Learn about habit formation in DSGE models through our comprehensive Matlab Dynare package! Delve into the fascinating dynamics of economic behavior, where past consumption patterns influence consumer preferences. Gain valuable insights into how habits shape key economic variables like savings, investment, and consumption. Elevate your modeling skills and empower your economic research with the ability to analyze habit formation's profound impact.
Access to the recording and COMPLETE material of my last webinar about habit formations in Matlab Dynare.
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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?
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.
