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Consumption Habits in a New Keynesian Business Cycle Model

  • RICHARD DENNIS

Consumption habits have become an integral component in new Keynesian models. However, consumption habits can be modeled in a host of different ways and this diversity is reflected in the literature. I examine whether different approaches to modeling consumption habits have important implications for business cycle behavior. Using a standard New Keynesian business cycle model, I show that, to a first-order log-approximation, the consumption Euler equation associated with the additive functional form for habit formation encompasses the multiplicative function form. Empirically, I show that whether consumption habits are internal or external has little effect on the model's business cycle characteristics. Copyright (c) 2009 The Ohio State University.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1538-4616.2009.00242.x
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 41 (2009)
Issue (Month): 5 (08)
Pages: 1015-1030

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Handle: RePEc:mcb:jmoncb:v:41:y:2009:i:5:p:1015-1030
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  1. Morten Ravn & Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Deep Habits," NBER Working Papers 10261, National Bureau of Economic Research, Inc.
  2. Andrew B. Abel, 1990. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
  3. Ryder, Harl E, Jr & Heal, Geoffrey M, 1973. "Optimum Growth with Intertemporally Dependent Preferences," Review of Economic Studies, Wiley Blackwell, vol. 40(1), pages 1-33, January.
  4. Gruber, Joseph W., 2004. "A present value test of habits and the current account," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1495-1507, October.
  5. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June.
  6. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  7. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, vol. 91(1), pages 149-166, March.
  8. Uribe, Martin, 2002. "The price-consumption puzzle of currency pegs," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 533-569, April.
  9. Richard Dennis, 2004. "Specifying and estimating New Keynesian models with instrument rules and optimal monetary policies," Working Paper Series 2004-17, Federal Reserve Bank of San Francisco.
  10. Jeffery D. Amato & Thomas Laubach, 2002. "Implications of habit formation for optimal monetary policy," BIS Working Papers 121, Bank for International Settlements.
  11. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
  12. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
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