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Habit formation: implications for the wealth distribution

  • Díaz, Antonia
  • Ríos Rull, José Víctor
  • Pijoan Mas, Josep

In this paper we study the role of habit formation in shaping the wealth distribution in an otherwise standard heterogeneous agents model economy with idiosyncratic uncertainty. We compare the inplications for precautionary savings and for wealth concentration between economies that only differ in the role played by habit formation. Once preferences are properly adjusted so that the Intertemporal Elasticity of Substituion is the same in all model economies studied, we find that habit formation brings a hefty increase in precautionary savings and very mild reductions in the coefficient of variation and in the Gini index of wealth. We also find that the reductions in these measures of inequality also hold when we adjust our economy so that aggregate savings are the same as in the economy without habit formation. These findings hold for both persistent and non persistent habits although for the former the quantitative size of the effects is much larger. We conclude that habit formation, while being a mechanism that increases the amount of precautionary savings generated in a model, does not change the implications for wealth inequality that arise from standard models.

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Paper provided by Universidad Carlos III de Madrid. Departamento de Economía in its series UC3M Working papers. Economics with number we015114.

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Date of creation: Dec 2001
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Handle: RePEc:cte:werepe:we015114
Contact details of provider: Web page: http://www.eco.uc3m.es/

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