Deep Habits Research Articles

The Impacts of Credit Standards on Aggregate Fluctuations in a Small Open Economy: The Role of Monetary Policy

Empirical evidence demonstrates that credit standards, including lending margins and collateral requirements, move in a countercyclical direction. In this study, we construct a small open economy model with financial frictions to generate the countercyclical movement in credit standards. Our analysis demonstrates that countercyclical fluctuations in credit standards work as an amplifier of shocks to the economy. In particular, the existence of endogenous credit standards increases output volatility by 21%. We also suggest three alternative tools for policymakers to dampen the effects of endogenous credit standards on macroeconomic volatility. First, the introduction of credit growth to the monetary policy succeeds in counteracting the fluctuation of lending, and thus decreasing the additional volatility considerably. Second, the exchange rate augmented monetary policy, if well-constructed, is considered an efficient tool to eliminate most of the additional fluctuations caused by deep habits in the banking sector. Finally, the introduction of the foreign interest augmented policy also proves successful in dampening the effect of endogenous movements in lending standards.

Deep habits and travel resilience after COVID-19

This research examines how deep travel habits in the form of habit formation and reduced substitutability between tourism travel and other leisure goods impact travel resilience after COVID-19. Using microdata for almost 3000 tourists in Andalusia (Spain), we relate post-pandemic outbreak tourism participation to pre-pandemic travelling intensity and whether taking a vacation is considered a priority good. In doing so, we control for standard sociodemographic characteristics and province fixed effects. Our results clearly show that the probability of continuing travelling during the summer of 2020 is positively associated with pre-pandemic travel intensity and tourism being considered a priority leisure activity. Travel resilience is found to be strongly associated with income, education level and the tenure of a second residence.

Inflationary Household Uncertainty Shocks

I construct a novel measure of household uncertainty based on survey data for European countries. I show that household uncertainty shocks are not universally like negative demand shocks. Notably, household uncertainty shocks are largely inflationary in Europe. These results lend support to a pricing bias mechanism as an important transmission channel. A comparison of results across countries suggest that demographics and factors related to average markups along with monetary policy play a role in the transmission of household uncertainty to inflation. I develop an Overlapping Generations New Keynesian model with Deep Habits to rationalize these results.

Security Governance and ASEAN’s Political Security Community: Fragmented but Inclusive Security Communities?

The establishment of the ASEAN Political and Security (APSC) in 2015 mimics the notion of a security community where member states are imbued with deep habits of cooperation, mutual trust, a sense of ‘we-feeling’ and the ability to manage security problems together with no prospects of any member going to war with another. But does a security community provide sufficient foundation for security governance in Southeast Asia? The idea of security governance, defined as a set of processes and arrangements carried out by a range of state and non-state actors across multiple levels from the local to the international that are aimed at defining and managing security challenges, requires a movement beyond state-centric approaches to one that is more participatory and inclusive. Despite the APSC’s people-centred rhetoric, there are inherent tensions in security practices in ASEAN as states hold on to the principles of non-interference and state sovereignty, while having to respond effectively to address a host of non-traditional threats. These tensions have led to the emergence of multiple sites of governance that are changing the nature of security governance in the region. In analysing the cases of civilian protection in times of humanitarian crises and forced migration, the paper argues that multiple sites of governance point to the need to reassess the APSC as a mechanism for security governance and explore the idea of having fragmented but more inclusive and participatory security communities that work together towards the shared goal of more secure region.

Deep habits and exchange rate pass-through

Habit persistence at the level of individual goods varieties can explain incomplete exchange rate pass-through to international prices. Deep habits give rise to a dynamic import demand function that leads to import price markup adjustments, independently of nominal pricing frictions. Augmenting a two-country DSGE model with deep habits, we obtain low exchange rate pass-through to import prices even when nominal local currency price rigidities are negligibly low. As nominal pricing frictions become more important, the presence of deep habits further impedes the pass-through of exchange rate fluctuations. Estimating model variants with limited information as well as full information methods, we find that the deep habits model requires much lower degrees of nominal price rigidities to match empirical measures of the pass-through of exchange rate fluctuations to US import prices.

Optimal Monetary Policy with Countercyclical Credit Spreads

AbstractWe study optimal monetary policy in a New‐Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with a credit channel and relationship lending in banking. We show that borrowers' bank‐specific (deep) habits give rise to countercyclical credit spreads, which, in turn, make optimal monetary policy depart substantially from price stability, under both discretion and commitment. Our analysis shows that the welfare costs of setting monetary policy under discretion (with respect to the optimal Ramsey plan) and of using simpler suboptimal policy rules are strictly increasing in the magnitude of deep habits in credit markets and market power in banking.

Too Slow a Change? Deep Habits, Consumption Shifts and Transitory Tax Policy

Too Slow a Change? Deep Habits, Consumption Shifts and Transitory Tax Policy

Addiction and the Brain: Development, Not Disease

I review the brain disease model of addiction promoted by medical, scientific, and clinical authorities in the US and elsewhere. I then show that the disease model is flawed because brain changes in addiction are similar to those generally observed when recurrent, highly motivated goal seeking results in the development of deep habits, Pavlovian learning, and prefrontal disengagement. This analysis relies on concepts of self-organization, neuroplasticity, personality development, and delay discounting. It also highlights neural and behavioral parallels between substance addictions, behavioral addictions, normative compulsive behaviors, and falling in love. I note that the short duration of addictive rewards leads to negative emotions that accelerate the learning cycle, but cortical reconfiguration in recovery should also inform our understanding of addiction. I end by showing that the ethos of the disease model makes it difficult to reconcile with a developmental-learning orientation.

Too Slow a Change? Deep Habits, Consumption Shifts and Transitory Tax Policy

Habits are an important cause of sluggish consumption adjustment in response to price shocks. This paper studies shifts within the consumption bundle under endogenous habit formation. I put forward a model with good-specific, or ’deep’, habits that cause persistence in good-specific consumption. In addition, at the aggregate level, habits act as a benchmark against which consumption is evaluated. I evaluate dynamic consumption choices under the realistic assumption that the consumer imperfectly internalizes the habit formation process. I compare consumption choices to the welfare-maximizing choices, and determine the path of taxes or subsidies that implements first-best consumption, both when goods are produced competitively and when they are produced by monopolists. I establish that a transition to a new consumption bundle is more likely inefficiently sluggish if the persistence effect is relatively strong. Strategic pricing behavior by monopolists leads to inefficiently rapid transitions. To explore the quantitative implications of the model I consider the introduction of a 10 percent charge on a subset of goods. I find that consumption adjusts inefficiently fast; implementing first-best adjustment requires a transitory discount of up to 60 percent of the cost increase.

Customer Capital, Markup Cyclicality, and Amplification

This paper studies the importance of firm-level price markup dynamics for business cycle fluctuations. Using state-of-the-art IO techniques to measure the behavior of markups over the business cycle at the firm level, I find that markups are countercyclical with an average elasticity of -1.1 with respect to real GDP. Importantly, I find substantial heterogeneity in markup cyclicality across firms, with small firms having significantly more counter-cyclical markups than large firms. Then, I develop a general equilibrium model by embedding customer capital (due to deep habits as in Ravn, Schmitt-Grohe, and Uribe, 2006) into a standard Hopenhayn (1992) model of firm dynamics with entry and exit. The calibrated model replicates these empirical facts and produces counter-cyclical firm sales dispersions consistent with the data. The resulting input misallocation amplifies both the volatility and persistence of the aggregate productivity shocks driving the business cycle.

On the gains from monetary policy commitment under deep habits

I study the welfare gains from commitment relative to discretion in the context of an equilibrium model that features deep habits in consumption. Policy simulations reveal that the welfare gains are increasing in the degree of habit formation and economically significant for a range of values consistent with U.S. data. I trace these results to the supply-side effects that deep habits impart on the economy and show that they ultimately weaken the stabilization trade-offs facing a discretionary planner. Most of the inefficiencies from discretion, it turns out, can be avoided by installing commitment regimes that last just two years or less. Extending the commitment horizon further delivers marginal welfare gains that are trivial by comparison.

Economic Openness and Fiscal Multipliers

ABSTRACTRecent empirical findings attribute a central role to the degree of economic openness to determine the size of the fiscal multiplier. See, for instance, Ilzetzki et al. (2013) [How big (small?) are fiscal multipliers? Journal of Monetary Economics, 60(2), 239–254]. However, traditional macroeconomic models have difficulties to account for this evidence. By introducing ‘deep-habit’ formation into a New Keynesian small open economy model, this paper provides a theoretical framework which is able to attest for the new empirical evidence. Deep habits give rise to counter-cyclical firm markups, which are crucial to generate effects of openness on the fiscal multiplier as found in the data. We study three dimensions of economic openness: exchange rate flexibility, trade openness, and capital mobility. In line with the empirical findings, we report a negative relationship between measures of economic openness and the fiscal multiplier.

On the Gains from Monetary Policy Commitment Under Deep Habits

I study the welfare gains from commitment relative to discretion in the context of an equilibrium model that features deep habits in consumption. Policy simulations reveal that the welfare gains are increasing in the degree of habit formation and economically significant for a range of values consistent with U.S. data. I trace these results to the supply-side effects that deep habits impart on the economy and show that they ultimately weaken the stabilization trade-offs facing a discretionary planner. Most of the inefficiencies from discretion, it turns out, can be avoided by installing commitment regimes that last just two years or less. Extending the commitment horizon further delivers marginal welfare gains that are trivial by comparison.

Deep habits: Workshop as critique in creative writing

The creative writing workshop, involving peer critique of manuscripts in progress, is deeply connected to many writerly habits of mind. As such, this article examines workshop as a signature pedagogy in creative writing. Through workshop, students develop awareness of their readers, understanding of how texts are created by readers and through process, and abilities to problem-solve in drafts and hone their personal tastes while encountering contemporary aesthetic values. At the same time, examination of the writerly habits of mind transmitted through workshop also reveals other key skills and ways of thinking that can be shortchanged when workshop is too much the sole methodology; one deleterious habit of mind, that of being overly self-critical, may even result.

Close-knit cities

Aristotle rightly holds that the constitution of a city is not entirely captured by its written documents or official political structures. More fundamentally, the constitution of a city is made up of its real and deep habits, customs, relations, expectations, aspirations, and ideals of the people who live there. The aim here is to articulate five values that together constitute what I will call close-knit cities: a) ecological resiliency; b) intimate proximity; c) social heterogeneity; d) fairness; e) social trust. I give a brief account of each of these values alone, along the way showing how each value needs the others to be fully realised, and ultimately argue that at least most cities should aspire to become close-knit cities because they simultaneously realise environmental stewardship and enable human flourishing.

Deep Habits and Exchange Rate Pass-Through

Deep Habits and Exchange Rate Pass-Through

Factor complementarity and labour market dynamics

We propose and estimate a dynamic stochastic general equilibrium model featuring search and matching frictions, deep habits and a CES production function. The model successfully replicates the cyclical properties of labour market variables in the US economy for three main reasons. First, two of the endogenous mechanisms of the model – factor complementarity and unemployment benefits – play a key role for explaining the amplification in unemployment and vacancies. Second, deep habits have a smaller but significant role as an endogenous mechanism. Third, capital-augmenting productivity, investment-specific and matching efficiency innovations explain large part of the variation in labour market variables.

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

This paper studies two frictions, good‐specific habit formation and price rigidities, used in theoretical models to generate the crowding‐in of consumption by expansionary government spending observed in the data. Both frictions generate countercyclical price markups, rising wages, and ensuing consumption–leisure substitution to overcome the negative wealth effect of the fiscal expansion. I demonstrate that while they independently support the rise of consumption, when used together the two frictions exert opposing pressures on the markup and the wage, weakening consumption–leisure substitution. Crucially, when price stickiness is high enough in an economy with “deep” habits, consumption is crowded out by the fiscal expansion.

Monetary and fiscal policy under deep habits

Allowing habits to be formed at the level of individual goods – deep habits - can radically alter the fiscal policy transmission mechanism as the counter-cyclicality of mark-ups this implies can result in government spending crowding-in rather than crowding-out private consumption in the short run. We explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. We then describe optimal monetary and fiscal policy in our New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple policy rules to mimic fully optimal policy. We find that the presence of deep habits at empirically estimated levels can imply large externalities that significantly affect the conduct of monetary and tax policy. However, despite the rise in government spending multipliers implied by deep habits, government spending is barely used as a stabilisation tool under the optimal policy.

Asset Prices and Real Exchange Rates with Deep Habits

I introduce an external habit for each consumption good, known as deep habits, into an otherwise standard international equilibrium model with multiple consumption goods and multiple countries. I show that deep habits coupled with consumption home bias account for a wide range of asset pricing and exchange rate moments. Calibrated to a set of ten countries, the model reproduces the cross-sectional evidence on currency risk premiums when sorting on interest rates, interest rate volatility, innovations to global exchange rate volatility, and value. Hence, the model provides an equilibrium interpretation of these empirical regularities.