Habits and durability in consumption, and the dynamics of the current account

Abstract

A model in which consumption exhibits durability, and habits develop over the flow of services provided by them is used to study current account dynamics. Durability leads to adjacent substitutability in consumption, while habits are assumed to lead to adjacent complementarity. The adjustment of the current account may be non-monotonic. If habit effects are dominant in the short run, and durability effects in the long run, then after a terms of trade deterioration we will have a current account deficit followed by a surplus (the J-curve). In the opposite case a surplus will be followed by a deficit. © 1998 Elsevier Science B.V.