Relative Consumption: The Strength of Internal and External Habits
33 Pages Posted: 3 Nov 2014 Last revised: 4 Nov 2014
Date Written: August 8, 2014
This paper investigates the presence and strength of internal and external habit formation in consumption, using monthly household data. The habit hypothesis is used to explain empirical regularities in macroeconomics and finance. Empirical studies based on aggregate data (macro-evidence) leave the micro-behavior unexplored. The micro-evidence is inconclusive and primarily based on food consumption data. Unfortunately, food consumption is a bad proxy for total consumption — mainly, because food consumption preferences differ considerably from consumption preferences of other goods (Shea (1994)). Thus, I use total household consumption data to test the Euler equations of an additive habit formation model. There is evidence for internal and external habits; the external habit effect is about three times larger than the internal effect. Extensions to alternative habit coefficients are provided.
Keywords: Behavioral Economics, Habit Formation, Social Comparison, Household Consumption, Dynamic Panel Data, Micro-Econometrics
JEL Classification: A12, C12, C23, C26, D12, D91
Suggested Citation: Suggested Citation