Consumption Commitments and Habit Formation
We analyze the implications of household-level adjustment costs for the dynamics of aggregate consumption. We show that an economy in which agents have “consumption commitments” 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.
Previously circulated as "Consumption Commitments: Neoclassical Foundations for Habit Formation." For helpful comments we thank John Campbell, Gary Chamberlain, Tom Davido¤, Drew Fudenberg, Elhanan Helpman, Miklos Koren, Hanno Lustig, Todd Sinai, Jeremy Stein, and Moto Yogo. For funding, Chetty and Szeidl thank the National Science Foundation (Grant SES 0522073), Szeidl thanks the Social Science Research Council, the Institute for Humane Studies, and the European Research Council under the European Unionʼs Seventh Framework Program (FP7/2007-2013), ERC grant agreement number 283484. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
Raj Chetty & Adam Szeidl, 2016. "Consumption Commitments and Habit Formation," Econometrica, Econometric Society, vol. 84, pages 855-890, 03. citation courtesy of