Deep Habits, Nominal Rigidities and the Response of Consumption to Fiscal Expansions

Punnoose Jacob and -
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Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium from Ghent University, Faculty of Economics and Business Administration

Abstract: Many empirical studies report that .fiscal expansions have a positive effect on private consumption. This paper provides a closer examination of the .deep. habits mechanism used by Ravn, Schmitt-Grohé and Uribe (2006) to generate the positive comovement between public and private consumption. In their set-up, habit-formation at the level of individual varieties makes the demand function facing the price-setting .firm, dynamic. This makes it optimal for the .firms to lower mark-ups of prices over nominal marginal costs when they expand production in response to the .fiscal expansion, leading to an increase in the demand for labor and hence the real wage rises. The consequent intra-temporal substitution of consumption for leisure triggers the positive response of consumption. Here, we show that increasing either price or nominal wage stickiness, reduces the impact of fiscal spending shocks on the mark-up and the real wage. Hence, consumption is still crowded out as in traditional models.

Keywords: Deep Habits; Sticky Prices; Sticky Wages; Fiscal Shocks; Crowding-out. (search for similar items in EconPapers)
JEL-codes: E21 E31 E62 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2010-02
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:rug:rugwps:10/641

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