Transcript Deep Habits

Deep Habits
Morten Ravn (EUI)
Stephanie Schmitt-Grohé (Duke)
Martín Uribe (Duke)
Existing Literature
• Habits are formed at the level of an aggregate
good. (Superficial Habits)
where
– Has demand side effect
Euler equation:
– But, no supply side effects! Demand function
for good i as in a model without habits:
Deep Habits
• This paper: Habits are formed at the level of individual
goods.
where
– Demand side (Euler equation) is identical under deep
and superficial external habits.
– However, supply side of the economy changes in
fundamental ways:
two implications
Price-elasticity Effect (I)
• Demand now has 2 components: one is price
elastic and one is price inelastic;
• Price elasticity of demand for each good is
increasing in aggregate demand (xt).
– Price elasticity procyclical;
Price-elasticity Effect (II)
• Fact: price mark-ups are inversely related to
price elasticity of demand;
• This implies that the behavior of mark-ups is
countercyclical!
• This is in line with empirical evidence
Intertemporal Effect
• Under deep habits firm´s pricing problem
becomes dynamic:
• each current unit of good i sold will affect its
future sales (magnitude of effect depends on the
interest rate)
Fully-fledged Model
• Slow decay in habits:
• capital accumulation
• introduce government (budget entirely financed by
lump-sum taxes)
-government consumption is subject to deep habit formation
Aggregate Dynamics
Main Results
•
As stated in the equilibrium conditions, deep
habits cause the price elasticity of demand to
be procyclical (hence mark-ups to be
countercyclical);
•
This implies:
i)
ii)
Procyclical real wages
Consumption increase with expenditure shocks
Extensions
• Isolating each of the deep habits’ effects:
– Price elasticity effect:
– Intertemporal effect:
Conclusions
• Deep habit formation implies that producers face
demand functions that depend on past sales,
inducing a theory of endogenous markup
determination.
• Under deep habits markups are countercyclical,
which is in line with empirical evidence.
• This has implications on the impulse responses
of wages and private consumption to an
exogenous government expenditures shock:
both variables increase, which is also in line with
the data (Gali et al., 2003; Blanchard and
Perotti, 2002; Fatás and Mihov, 2001).