Do habits generate endogenous fluctuations in a growing economy?

Abstract

This article examines endogenous fluctuations under habit persistence in preferences using an otherwise standard one-sector endogenous growth model with fiscal government policies. I show that a continuum of competitive transitional equilibrium paths exists, in conjunction with a globally unique balanced growth path, when a household's preferences are characterized by habit persistence in a growing competitive economy with exogenous fiscal policies, namely, income taxes and productive public spending. Indeterminacy also emerges in the socially efficient second-best allocation even when the government intends to internalize habit externalities, including jealousy and admiration, by introducing optimal time-variant income taxes and public capital services. Therefore, in the presence of multiple competitive equilibria and socially efficient allocations and in the absence of continuous exogenous stochastic shocks, self-fulfilling beliefs drive endogenous business cycles in these growing economies.