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Habit formation and the government spending multiplier

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  • Aloui, Rym

Abstract

This paper explores the impact of habit formation on government spending multipliers (GSMs) within a New Keynesian framework, challenging the widely held belief that GSMs are significantly larger when nominal interest rates are low. We present a novel channel that affects the size of GSM by introducing deep habit preferences, which include consumption habits at the variety level. During periods of persistently low nominal interest rates, deep habits result in more moderate GSM levels, albeit still above 1. Furthermore, deep habits reduce the gap in GSM sizes between the constrained regime, in which the nominal interest rate is fixed at the effective lower bound, and the conventional regime, which is characterized by an endogenous Taylor-type nominal interest rate rule. This study emphasizes the importance of habit formation in understanding GSM mechanisms and contributes to the discussion of fiscal policy effectiveness in a low nominal interest rate environment.

Suggested Citation

  • Aloui, Rym, 2024. "Habit formation and the government spending multiplier," Economic Modelling, Elsevier, vol. 132(C).
    • Handle: RePEc:eee:ecmode:v:132:y:2024:i:c:s0264999324000105
    DOI: 10.1016/j.econmod.2024.106654
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    Keywords

    Government spending multiplier; Deep habits; Monetary–fiscal policy regime; Effective lower bound;
    All these keywords.

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents

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