Buffer Stock Saving and Habit Formation

46 Pages Posted: 4 Mar 2002

See all articles by Alexander Michaelides

Alexander Michaelides

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Date Written: February 26, 2002

Abstract

This paper investigates whether an infinite horizons buffer stock saving model with internal, multiplicative, habit formation preferences can replicate the macroeconomic stylized facts about consumption expenditures on non-durables and services. Individual consumption smoothing and consumption sensitivity to lagged earnings induced by habit formation survive the numerical aggregation procedure replicating in magnitude the observed smoothness of aggregate non-durables consumption growth and the sensitivity of current consumption growth to lagged labor income growth. Nevertheless, this empirical success is associated with substantial wealth accumulation. To the extent, therefore, that the buffer stock model without habits adequately replicates the wealth accumulation profile of the median consumer, the proposed modification cannot jointly explain in magnitude the smoothness of consumption and its excess sensitivity to lagged labor income.

Keywords: Habit Formation, Buffer Stock Saving, Undiversifiable Labor Income Risk, Excess Sensitivity, Smoothness of Consumption

JEL Classification: E2

Suggested Citation

Michaelides, Alexander, Buffer Stock Saving and Habit Formation (February 26, 2002). Available at SSRN: https://ssrn.com/abstract=302079 or http://dx.doi.org/10.2139/ssrn.302079

Alexander Michaelides (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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