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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.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2008-35.

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Date of creation: 2008
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Handle: RePEc:fip:fedfwp:2008-35
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  1. Jeffery D. Amato & Thomas Laubach, 2001. "Implications of habit formation for optimal monetary policy," Finance and Economics Discussion Series 2001-58, Board of Governors of the Federal Reserve System (U.S.).
  2. Uribe, Martin, 2002. "The price-consumption puzzle of currency pegs," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 533-569, April.
  3. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1999. "Habit persistence, asset returns and the business cycles," Working Paper Series WP-99-14, Federal Reserve Bank of Chicago.
  4. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  5. Morten Ravn & Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Deep Habits," NBER Working Papers 10261, National Bureau of Economic Research, Inc.
  6. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 1-90, Wharton School Rodney L. White Center for Financial Research.
  7. 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.
  8. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  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. Christopher D. Carroll & Jody Overland & David N. Weil, 1995. "Saving and growth with habit formation," Finance and Economics Discussion Series 95-42, Board of Governors of the Federal Reserve System (U.S.).
  11. 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.
  12. 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.
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