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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. 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.
  2. Morten Ravn & Stephanie Schmitt-Grohé & Mart�n Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
  3. Jaime Alonso-Carrera & Jordi Caballé & Xavier Raurich, 2004. "Aspirations, Habit Formation, and Bequest Motive," UFAE and IAE Working Papers 641.04, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  4. BOUCEKKINE, Raouf & LICANDRO, Omar & PUCH, Luis A. & DEL RIO, Fernando, . "Vintage capital and the dynamics of the AK model," CORE Discussion Papers RP -1757, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Kareen Rozen, 2008. "Foundations of Intrinsic Habit Formation," Levine's Working Paper Archive 122247000000002062, David K. Levine.
  6. Jaime Alonso-Carrera & Jordi Caballé & Xavier Raurich, 2005. "Estate Taxes, Consumption Externalities, and Altruism," UFAE and IAE Working Papers 658.05, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  7. 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).
  8. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  9. 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.
  10. Cooper, B. & Garcia-Penalosa, C., 1998. "Status Effects and Neganive Utility Growth," Economics Papers 150, Economics Group, Nuffield College, University of Oxford.
  11. repec:bla:restud:v:77:y:2010:i:4:p:1382-1402 is not listed on IDEAS
  12. Francisco Alvarez-Cuadrado & Goncalo Monteiro & Stephen J. Turnovsky, 2004. "Habit Formation, Catching Up with the Joneses, and Economic Growth," Journal of Economic Growth, Springer, vol. 9(1), pages 47-80, 03.
  13. 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.
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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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