Habit formation in DSGE Models
In our simple RBC model, we made the assumption that the utility of the families is solely based on their present consumption and that the decision-making process of individuals is not influenced by their past consumption behavior. While this assumption may provide a useful simplification for some analyses, it is not always reflective of real-life situations.
In reality, consumers tend to develop consumption habits that are informed by their past experiences. What they consumed in the past often influences their current consumption decisions, and those decisions, in turn, impact future consumption. Consequently, the problem becomes much more nuanced and complex.
If we consider the impulse response functions in the basic RBC model, we can see that when there is a technology shock, consumption responds abruptly and reaches its peak immediately. However, in the presence of habit formations, consumption follows a different pattern. It reaches its peak gradually, taking some time to adjust to the shock, and following a hump-shaped curve.
Why does this happen? As we previously mentioned, consumers have habitual patterns of consumption that are difficult to change immediately after a shock. They need time to adjust and adapt to the new situation. This gradual shift in consumption patterns is a more realistic representation of how individuals react to changes in the economy.
In summary, incorporating habit formations into our RBC model provides a more realistic view of how consumption behavior evolves over time. It adds a layer of complexity that is necessary to capture the nuances of real-world economic dynamics.
Doesn't this sound more realistic?
- Individuals should have Matlab-Dynare installed.
- We will build upon the simple RBC model covered in the DSGE Course and add habit formation/habit persistence to the household's maximization problem
- The price of the webinar is CAD 5.99
- How to sign up? Click on "Buy Now" and you will get a document with the link to the meeting.
- The webinar should last between 40 mins to an hour (max).
- You can't make it on that day? Don't worry! You will still get the material and video recording.
After the webinar you will get…..
- Slides with the explanations
- PDF With step by step resolutions
- The Matlab File to replicate the results
Impulse Response Function
Consumption has now taken on a pronounced hump shape, taking a longer period of time to reach its peak. The reason for this is due to consumers' consumption habits. When there is a shock to the economy, such as an expansion or contraction, individuals tend to smooth their consumption and maintain a similar basket of goods and services. This is where habit persistence comes into play and it is important to understand how policymakers may not be able to obtain immediate results after modifying their monetary policy. Consumers may not be very responsive to changes in the interest rate, as they will continue to consume the same basket of goods and services, at least for a period of time.
DSGE Webinar : Habit Formation
Join me on my next webinar!
We will learn how to include habit formation to the families utility function.
After the webinar, get:
- PDF with step by step explanations
- Matlab Code
- Video Recording
NOTE: THE TUTORIAL IS USING DYNARE IN MATLAB
THE TUTORIAL IS AN EXTENSION OF THE BASELINE RBC MODEL COVERED IN THE DSGE COURSE.