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Habit Formation in an Interdependent World Economy

Author

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  • Shinsuke Ikeda
  • Ichiro Gombi

Abstract

In a two-country world economy, consumption-habit dynamics in one country are affected, due to endogenous interest rate adjustments, by the other country's habits and preferences. External indebtedness depends crucially on international differences in habit-adjusted net output less habitual living standard. Interest rate adjustments enlarge the consumption impact of an income shock. Consistently with the empirical facts, the habit parameter of a large country, therefore, would be underestimated, and the current account volatility overestimated, if estimated using a small-country model. An increase in fiscal spending in one country can benefit the country and harm the neighbor due to intertemporal terms-of-trade effects.

Suggested Citation

  • Shinsuke Ikeda & Ichiro Gombi, 2004. "Habit Formation in an Interdependent World Economy," ISER Discussion Paper 0619r, Institute of Social and Economic Research, The University of Osaka, revised Jul 2008.
    • Handle: RePEc:dpr:wpaper:0619r
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    File URL: https://www.iser.osaka-u.ac.jp/static/resources/docs/dp/2008/DP0619-R.pdf
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    References listed on IDEAS

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