Habit persistence and stagnation

Abstract

Using a money-in-the-utility function model that incorporates habit formation in consumption, we consider the question of how allowing for habit formation affects the possibility of a persistent shortage of consumption. We then contrast the model without habits with a model with habits. The main findings of our analysis are that i) when the degree of habit formation is important, a high degree of habit persistence opens up the possibility of a shortage of consumption, and ii) in the steady state with stagnation, the equilibrium consumption in the model with habit formation is smaller than the corresponding consumption without habits.