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Consumption-habits in a new Keynesian business cycle model

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  • Richard Dennis

Abstract

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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  • Richard Dennis, 2008. "Consumption-habits in a new Keynesian business cycle model," Working Paper Series 2008-35, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2008-35
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    References listed on IDEAS

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    1. 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.
    2. 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.
    3. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
    4. 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.
    5. Amato, Jeffery D. & Laubach, Thomas, 2004. "Implications of habit formation for optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 305-325, March.
    6. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    7. 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.
    8. Morten Ravn & Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
    9. 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.
    10. 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.
    11. Uribe, Martin, 2002. "The price-consumption puzzle of currency pegs," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 533-569, April.
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    Keywords

    Business cycles;

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