Habit formation and sunspots in overlapping generations models

Fabrizio Orrego ()

No 2011-013, Working Papers from Banco Central de Reserva del Perú

Abstract: I introduce habit formation into an otherwise standard overlapping generations economy with pure exchange populated by three-period-lived agents. Habits are modeled in such a way that current consumption increases the marginal utility of future consumption. With logarithmic utility functions, I demonstrate that habit formation may give rise to stable monetary steady states in economies with hump-shaped endowment pro les and reasonably high discount factors. Intuitively, habits imply adjacent complementarity in consumption, which in turn helps explain why income effects are sufficiently strong in spite of logarithmic utility. The longer horizon further strengthens the income effect. Finally, I use the bootstrap method to construct stationary sunspot equilibria for those economies in which the steady state is locally stable.

Date: 2011-08
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