UK Consumers' Habits

External MPC Unit Discussion Paper No. 13

36 Pages Posted: 15 Oct 2011

See all articles by Ryan Banerjee

Ryan Banerjee

Bank for International Settlements (BIS)

Nicoletta Batini

International Monetary Fund (IMF)

Date Written: May 1, 2003

Abstract

We follow Fuhrer (2000) in estimating via Maximum Likelihood a log-linear consumption function on UK data. In doing so we consider various habit formation assumptions. We show that a model of purely “external” habits as in Fuhrer (2000) fits the UK data remarkably well, and possibly in a superior way than US data where, according to our estimates, consumers’ habits look more “internal” in that they appear indexed to past average consumption of only a subset of (peer) consumers in the economy, rather than total past per capita consumption. We also find that for about one seventh of UK consumers, current consumption equals current income a strong violation of the permanent income hypothesis. Embedded in a sticky price-sticky inflation open-economy monetary model, the model that we estimate helps mimic the hump-shaped response of the output gap to income and interest rate shocks observed in the UK. Estimates of output Euler equations for the UK using a similar method agree with our general results. The consumption and output models that we estimate forecast significantly better than unrestricted open-economy VARs.

Keywords: consumption, habit formation, output gap channel

JEL Classification: D12, E52, E43

Suggested Citation

Banerjee, Ryan and Batini, Nicoletta, UK Consumers' Habits (May 1, 2003). External MPC Unit Discussion Paper No. 13, Available at SSRN: https://ssrn.com/abstract=1943770 or http://dx.doi.org/10.2139/ssrn.1943770

Ryan Banerjee (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Nicoletta Batini

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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