Habit persistence and stagnation

Using a money-in-the-utility function model that incorporates habit formation in consumption, we consider the question of how allowing for habit formation affects the possibility of a persistent shortage of consumption. We then contrast the model without habits with a model with habits. The main findings of our analysis are that i) when the degree of habit formation is important, a high degree of habit persistence opens up the possibility of a shortage of consumption, and ii) in the steady state with stagnation. the equilibrium consumption in the model with habit formation is smaller than the corresponding consumption without habits. (C) 2009 Elsevier B.V. All rights reserved.