The Korean Economic Review
Deep Habits, Rule-of-Thumb Consumers, and Fiscal Policy
Daeha Cho (Boston University) and Kwang Hwan Kim (Yonsei University)Year 2013Vol. 29No. 2
Procyclical movements in private consumption and countercyclical markup are the most prominent feature to an increase in government spending. In this paper, we model deep habits and rule-of-thumb consumers to match this feature. We demonstrate that when ruleof-thumb consumers meet deep habits in consumption, our model improves the two models that are widely used in the literature to investigate the effect of government spending. First,it generates a more realistic markup response. Second, it reduces the threshold value of ruleof-thumb share necessary to crowd in consumption. The main reason behind the success is because both deep habits and rule-of-thumb consumers mutually reinforce.