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Does habit formation always increase the agents' desire to smooth consumption?

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  • Emmanuelle Augeraud-Veron
  • Mauro Bambi

Abstract

In the literature, habit formation has been often introduced to enhance the agents' desire to smooth consumption over time. This characteristic was found particularly useful in solving the equity premium puzzle and in matching several stylized facts in growth, and business cycles theory as, for example, the high persistence in the U.S. output volatility. In this paper we propose a definition of habit formation, which is ``general'' relative to the assumptions on the intensity, persistence, and lag structure, and we unveil two mechanisms which point to the opposite direction: habits may reduce the desire of smoothing consumption over time and then may potentially decrease the power of a model in explaining the previously mentioned facts. More precisely, we propose a complete taxonomy of the rich dynamics which may emerge in an AK model with external addictive habits for all the feasible combinations of the intensity, persistence and lag structure characterizing their formation and we point out to the region in the parameters' space coherent with less smoothing in consumption. An economic explanation of these mechanisms is suggested and the robustness of our results in the case of internal habits verified. Finally and crucially habit formation always reduces the desire of consumption smoothing once the model is calibrated to match the average U.S. output and utility growth rates observed in the data.

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Bibliographic Info

Paper provided by Department of Economics, University of York in its series Discussion Papers with number 12/12.

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Date of creation: Apr 2012
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Handle: RePEc:yor:yorken:12/12

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Keywords: Habit formation; endogenous fluctuations; delayed functional differential equations.;

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References

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  1. Boucekkine, Raouf & Del Rio, Fernando & Licandro, Omar, 2000. "Vintage capital and the dynamics of the AK model," CEPREMAP Working Papers (Couverture Orange) 0003, CEPREMAP.
  2. Jaime Alonso-Carrera & Jordi Caballe & Xavier Raurich, 2004. "Aspirations, Habit Formation, and Bequest Motive," Working Papers 136, Barcelona Graduate School of Economics.
  3. Jaime Alonso-Carrera & Jordi Caballe & Xavier Raurich, 2005. "Estate Taxes, Consumption Externalities, and Altruism," Working Papers 232, Barcelona Graduate School of Economics.
  4. repec:bla:restud:v:77:y:2010:i:4:p:1382-1402 is not listed on IDEAS
  5. Cooper, B. & Garcia-Penalosa, C., 1998. "Status Effects and Neganive Utility Growth," Economics Papers 150, Economics Group, Nuffield College, University of Oxford.
  6. Hippolyte D'Albis & Emmanuelle Augeraud-Véron & Hermen Jan Hupkes, 2012. "Discontinuous Initial Value Problems for Funtional Differential-Algebraic Equations of Mixed Type," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00717412, HAL.
  7. Kareen Rozen, 2008. "Foundations of Intrinsic Habit Formation," Cowles Foundation Discussion Papers 1642, Cowles Foundation for Research in Economics, Yale University.
  8. Alonso-Carrera, Jaime & Caballe, Jordi & Raurich, Xavier, 2005. "Growth, habit formation, and catching-up with the Joneses," European Economic Review, Elsevier, vol. 49(6), pages 1665-1691, August.
  9. Morten Ravn & Stephanie Schmitt-Grohé & Mart�n Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
  10. Francisco Alvarez-Cuadrado & Goncalo Monteiro & Stephen Turnovsky, 2004. "Habit Formation, Catching Up with the Joneses, and Economic Growth," Working Papers UWEC-2004-09-P, University of Washington, Department of Economics, revised Jan 2004.
  11. Mauro BAMBI & Giorgio FABBRI & Fausto GOZZI, 2010. "Optimal policy and consumption smoothing effects in the time-to-build AK model," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2010029, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  12. Fabbri, Giorgio & Gozzi, Fausto, 2008. "Solving optimal growth models with vintage capital: The dynamic programming approach," Journal of Economic Theory, Elsevier, vol. 143(1), pages 331-373, November.
  13. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Does habit formation always increase the agents’ desire to smooth consumption?
    by Christian Zimmermann in NEP-DGE blog on 2012-04-22 23:42:02
  2. Beyond models
    by chris dillow in Stumbling and Mumbling on 2012-07-26 13:23:50
  3. Does habit formation always increase the agents’ desire to smooth consumption?
    by Christian Zimmermann in NEP-DGE blog on 2012-04-22 23:42:02

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