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Habits, Costly Investment, and Current Account Dynamics

  • Ikeda, S.
  • Gombi, I.

Using a small country model with habit-forming consumers and costly investment, we analyze equilibrium dynamics of the economy and derive empirical and welfare implications. The model can mimic some stylized facts: (i) a temporary increase in fiscal spending always deteriorates the current account whereas a permanent increase in fiscal spending may have a weaker effect; (ii) permanent productivity shocks deteriorate the current account; and (iii) savings and investment tend to co-move upon macroeconomic shocks. Strong habit persistence causes sluggishness in welfare dynamics. Consequently, a beneficial fiscal policy may have a harmful hangover effect on the future welfare.

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Paper provided by Institute of Social and Economic Research, Osaka University in its series ISER Discussion Paper with number 0442.

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Length: 24 pages
Date of creation: 1995
Date of revision:
Handle: RePEc:dpr:wpaper:0442
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  23. Shi, Shouyong & Epstein, Larry G, 1993. "Habits and Time Preference," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(1), pages 61-84, February.
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  26. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 54-77, February.
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  30. Sen, Partha & Turnovsky, Stephen J., 1989. "Deterioration of the terms of trade and capital accumulation: A re-examination of the Laursen-Metzler effect," Journal of International Economics, Elsevier, vol. 26(3-4), pages 227-250, May.
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