Consumption-Habits in a New Keynesian Business Cycle Model


Richard Dennis

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2008-35 | December 1, 2008

Consumption-habits have become an integral component in new Keynesian models. However, consumption-habits can be modeled in a host of different ways and this diversity is reflected in the literature. I examine whether different approaches to modeling consumption habits have important implications for business cycle behavior. Using a standard new Keynesian business cycle model, I show that, to a first-order log-approximation, the consumption Euler equation associated with the additive functional form for habit formation encompasses the multiplicative function form. Empirically, I show that whether consumption habits are internal or external has little effect on the model’s business cycle characteristics.

Article Citation

Dennis, Richard. 2008. “Consumption-Habits in a New Keynesian Business Cycle Model,” Federal Reserve Bank of San Francisco Working Paper 2008-35. Available at