Consumption Commitments and Habit Formation

Raj Chetty and Adam Szeidl

No 10970, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We analyze the implications of household-level adjustment costs for the dynamics of aggregate consumption. We show that an economy in which agents have “consumption commitments” is approximately equivalent to a habit formation model in which the habit stock is a weighted average of past consumption if idiosyncratic risk is large relative to aggregate risk. Consumption commitments can thus explain the empirical regularity that consumption is excessively sensitive and excessively smooth, findings that are typically attributed to habit formation. Unlike habit formation and other theories, but consistent with empirical evidence, the consumption commitments model also predicts that excess sensitivity and smoothness vanish for large shocks. These results suggest that behavior previously attributed to habit formation may be better explained by adjustment costs. We develop additional testable predictions to further distinguish the commitment and habit models and show that the two models have different welfare implications.

JEL-codes: D8 E21 G11 G12 (search for similar items in EconPapers)
Date: 2004-12
New Economics Papers: this item is included in nep-dge, nep-fin and nep-mac
Note: EFG PE
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Published as Raj Chetty & Adam Szeidl, 2016. "Consumption Commitments and Habit Formation," Econometrica, Econometric Society, vol. 84, pages 855-890, 03.

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Journal Article: Consumption Commitments and Habit Formation (2016)
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