NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Consumption Commitments and Habit Formation

Raj Chetty, Adam Szeidl

NBER Working Paper No. 10970
Issued in December 2004, Revised in September 2015
NBER Program(s):EFG, PE

We analyze the implications of household-level adjustment costs for the dynamics of aggregate consumption. We show that an economy in which agents have ‚Äúconsumption commitments‚ÄĚ is approximately equivalent to a habit formation model in which the habit stock is a weighted average of past consumption if idiosyncratic risk is large relative to aggregate risk. Consumption commitments can thus explain the empirical regularity that consumption is excessively sensitive and excessively smooth, findings that are typically attributed to habit formation. Unlike habit formation and other theories, but consistent with empirical evidence, the consumption commitments model also predicts that excess sensitivity and smoothness vanish for large shocks. These results suggest that behavior previously attributed to habit formation may be better explained by adjustment costs. We develop additional testable predictions to further distinguish the commitment and habit models and show that the two models have different welfare implications.

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Document Object Identifier (DOI): 10.3386/w10970

Published: Raj Chetty & Adam Szeidl, 2016. "Consumption Commitments and Habit Formation," Econometrica, Econometric Society, vol. 84, pages 855-890, 03. citation courtesy of

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