Habits, Rationality and Myopia in the Life Cycle Consumption Function

John N. J. Muellbauer

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Abstract

This paper considers the effect both on solved-out, forward-looking consumption functions and on Euler equations of two alternative hypotheses about habits: rational habits assume that consumers are aware of the effect of their current consumption decisions on their future marginal rates of substitution; under myopic habits, they are not aware. Demand-systems evidence suggests there are important habits effects for most consumption goods, but time series models of aggregate consumption have found only a low degree of habit persistence, a result confirmed here by an analysis of quarterly U.S. data based on Euler equations. Taken together, the evidence appears to favor the hypothesis of myopic habits.

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References

1980An Almost Ideal Demand System 1978Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence 2013Utility Analysis and the Consumption Function: An Interpretation of Cross-Section Data 1960A Theory of the Consumption Function 1950Income, Saving and the Theory of Consumer Behavior.1963THE LIFE CYCLE HYPOTHESIS OF SAVING: AGGREGATE IMPLICATIONS AND TESTS 1978Econometric Modelling of the Aggregate Time-Series Relationship Between Consumers' Expenditure and Income in the United Kingdom 1981The Adjustment of Consumption to Changing Expectations About Future Income

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2006How Large Is the Housing Wealth Effect? A New Approach 1991Habit Formation, Interdependent Preferences and Demographic Effects in the Almost Ideal Demand System 2000Solving consumption models with multiplicative habits 1992Understanding Consumption 2005Habit Persistence and Keeping Up with the Joneses:Evidence from Micro Data

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