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Deep Habits

  • Morten O. Ravn
  • Stephanie Schmitt-Grohe

This paper generalizes the standard habit formation model to an environment in which agents form habits over individual varieties of goods as opposed to over a composite consumption good. We refer to this preference specification as ‘deep habit formation’. Under deep habits, the demand function faced by individual producers depends on past sales. This feature is typically assumed ad-hoc in customer market and brand switching cost models. A central result of the paper is that deep habits give rise to countercyclical markups, which is in line with the empirical evidence. This result is important because ad-hoc formulations of customer-market and switching-cost models have been criticized for implying procyclical and hence counterfactual markup movements. The paper also provides econometric estimates of the parameters pertaining to the deep habit model

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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 208.

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Date of creation: 2004
Date of revision:
Handle: RePEc:red:sed004:208
Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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  1. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  2. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  3. Ravn, Morten O & Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Deep Habits," CEPR Discussion Papers 4269, C.E.P.R. Discussion Papers.
  4. Jordi Galí, 1993. "Monopolistic competition, business cycles and the composition of aggregate demand," Economics Working Papers 45, Department of Economics and Business, Universitat Pompeu Fabra.
  5. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  6. Ferson, Wayne E. & Constantinides, George M., 1991. "Habit persistence and durability in aggregate consumption: Empirical tests," Journal of Financial Economics, Elsevier, vol. 29(2), pages 199-240, October.
  7. Andrew B. Abel & Avinash K. Dixit & Janice B. Eberly & Robert S. Pindyck, . "Options, the Value of Capital, and Investment," Rodney L. White Center for Financial Research Working Papers 15-95, Wharton School Rodney L. White Center for Financial Research.
  8. Julio J. Rotemberg & Michael Woodford, 1989. "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity," NBER Working Papers 3206, National Bureau of Economic Research, Inc.
  9. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  10. Bils, Mark, 1989. "Pricing in a Customer Market," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 699-718, November.
  11. Thomas D. Tallarini, Jr. & Harold H. Zhang, 2005. "External habit and the cyclicality of expected stock returns," Finance and Economics Discussion Series 2005-27, Board of Governors of the Federal Reserve System (U.S.).
  12. Julio J. Rotemberg & Michael Woodford, 1991. "Markups and the Business Cycle," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 63-140 National Bureau of Economic Research, Inc.
  13. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
  14. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 01-90, Wharton School Rodney L. White Center for Financial Research.
  15. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  16. Braun, Phillip A. & Constantinides, George M. & Ferson, Wayne E., 1993. "Time nonseparability in aggregate consumption : International evidence," European Economic Review, Elsevier, vol. 37(5), pages 897-920, June.
  17. Dunn, Kenneth B. & Singleton, Kenneth J., 1986. "Modeling the term structure of interest rates under non-separable utility and durability of goods," Journal of Financial Economics, Elsevier, vol. 17(1), pages 27-55, September.
  18. Heaton, John, 1995. "An Empirical Investigation of Asset Pricing with Temporally Dependent Preference Specifications," Econometrica, Econometric Society, vol. 63(3), pages 681-717, May.
  19. Klemperer, Paul, 1995. "Competition When Consumers Have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade," Review of Economic Studies, Wiley Blackwell, vol. 62(4), pages 515-39, October.
  20. Rotemberg, Julio J & Saloner, Garth, 1986. "A Supergame-Theoretic Model of Price Wars during Booms," American Economic Review, American Economic Association, vol. 76(3), pages 390-407, June.
  21. Julio J. Rotemberg & Michael Woodford, 1993. "Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets," NBER Working Papers 4502, National Bureau of Economic Research, Inc.
  22. 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.
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