Deep Habits, Price Rigidities and the Consumption Response to Government Spending

Punnoose Jacob

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

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 labor 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.

Keywords: Deep Habits; Sticky Prices; Government Spending; Crowding-out (search for similar items in EconPapers)
JEL-codes: E21 E31 E62 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2013-11
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Deep Habits, Price Rigidities, and the Consumption Response to Government Spending (2015)
Working Paper: Deep habits, price rigidities and the consumption response to Government spending (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2013-72

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