Working Paper: NBER ID: w10970
Authors: Raj Chetty; Adam Szeidl
Abstract: 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.
Keywords: No keywords provided
JEL Codes: D8; E21; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| household consumption commitments (D10) | aggregate consumption dynamics (E21) |
| idiosyncratic risk is large relative to aggregate risk (D81) | household consumption commitments (D10) |
| household consumption commitments (D10) | excess sensitivity and smoothness of consumption (D11) |
| large shocks (E32) | consumption commitments (E21) |
| large shocks (E32) | immediate adjustment in consumption behavior (D12) |
| small shocks (E32) | sluggish adjustments in consumption behavior (D15) |