Habit Formation and Aggregate Consumption Dynamics

Advances in Macroeconomics, 2007, vol. 7, issue 1, pages 1444-1444

Abstract: This paper finds that a benchmark model of habit formation in consumer preferences can explain two well-known failures of the permanent income hypothesis: the sensitivity of aggregate consumption to predictable changes in income and to lagged consumer sentiment. One novel feature of the paper's methodology is to allow for measurement errors and other transitory elements (for example, weather-related disturbances) in consumption data. In contrast with traditional wisdom, aggregate consumption growth appears to be highly persistent after controlling for measurement errors and transitory consumption fluctuations: the estimates of persistence in quarterly consumption growth jump up from the commonly assumed 0.3 to about 0.7.

Keywords: consumer sentiment; excess sensitivity; habit formation; measurement error; sticky expectations (search for similar items in EconPapers)
JEL-codes: E10 (search for similar items in EconPapers)
Note: oai:bepress:bejm-1444
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