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Deep habits, price rigidities and the consumption response to Government spending

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Abstract

This paper presents the novel implications of introducing price rigidities into a model of good-specific habit formation, for the response of private consumption following a positive government spending shock. With 'deep' habits in demand, the price elasticity of demand rises after the fiscal expansion and it is optimal for the firm to lower the mark-up while increasing production. This in turn raises the demand for labour and the real wage rises. Consequently, agents raise consumption at the expense of leisure and overcome the negative wealth effect of the fiscal shock. We show that increasing price stickiness in a model with deep habits hinders the crowding-in of consumption. If the degree of price stickiness is high enough, consumption is crowded out by government spending. These dynamics are in stark contrast to those in traditional models where price rigidities are known to weaken the crowding-out of consumption.

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  • Punnoose Jacob, 2013. "Deep habits, price rigidities and the consumption response to Government spending," Reserve Bank of New Zealand Discussion Paper Series DP2013/03, Reserve Bank of New Zealand.
  • Handle: RePEc:nzb:nzbdps:2013/03
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    References listed on IDEAS

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    Cited by:

    1. Anna Kormilitsina & Sarah Zubairy, 2015. "Propagation Mechanisms for Government Spending Shocks: A Bayesian Comparison," EcoMod2015 8646, EcoMod.
    2. Cristiano Cantore & Paul Levine & Giovanni Melina, 2014. "Deep versus superficial habit: It’s all in the persistence," School of Economics Discussion Papers 0714, School of Economics, University of Surrey.
    3. Punnoose Jacob, 2015. "Deep Habits, Price Rigidities, and the Consumption Response to Government Spending," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(2-3), pages 481-510, March.
    4. B. Verhelst & D. Van Den Poel, 2012. "Deep Habits in Consumption: A Spatial Panel Analysis Using Scanner Data," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 12/823, Ghent University, Faculty of Economics and Business Administration.
    5. repec:taf:intecj:v:31:y:2017:i:1:p:1-35 is not listed on IDEAS
    6. Cantore, Cristiano & Levine, Paul & Melina, Giovanni & Yang, Bo, 2012. "A fiscal stimulus with deep habits and optimal monetary policy," Economics Letters, Elsevier, vol. 117(1), pages 348-353.
    7. Benjamin Verhelst & Dirk Van den Poel, 2014. "Deep habits in consumption: a spatial panel analysis using scanner data," Empirical Economics, Springer, vol. 47(3), pages 959-976, November.
    8. Luca, Pieroni & Lorusso, Marco, 2015. "Are all the fiscal policy shocks identical? Analysing the effects on private consumption of civilian and military spending shocks," MPRA Paper 69151, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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