Working Paper: CEPR ID: DP3520
Authors: Raquel Carrasco; J. Maria Labeaga Azcona; J. David López Salido
Abstract: The purpose of this Paper is to test for the presence of habit formation in consumption decisions using household panel data. We use the test proposed by Meghir and Weber (1996) and estimate the within-period marginal rate of substitution between commodities, which is robust to the presence of liquidity constraints. To that end, we use a Spanish panel dataset in which households are observed up to eight consecutive quarters. This temporal dimension is crucial, since it allows us to take into account time invariant unobserved heterogeneity across households ('fixed effects') and, therefore, to investigate if the relationship between current and past consumption reflects habits or heterogeneity. Our results confirm the importance of accounting for fixed effects when analysing intertemporal consumption decisions allowing for time non-separabilities. Once fixed effects are controlled for and a proper set of instruments is used, the results yield supporting evidence of habit formation in the demand system of food at home, transport and services.
Keywords: consumption; habits; panel data
JEL Codes: C33; D12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fixed effects not accounted for (C23) | Preferences appear intertemporally separable (D15) |
| Controlling for fixed effects + proper instruments (C36) | Evidence of habit formation in consumption of food and transport (D12) |
| Unobserved heterogeneity (C21) | Relationship between past and current consumption (D15) |
| MRS for food and transport (R49) | Significant habit persistence (D15) |
| Liquidity constraints (E51) | Consumption dynamics (E21) |