Deep Consumer Habits and Fiscal Policy Shocks

This paper examines two questions using a stochastic general equilibrium model for a small open export-oriented economy. First, the action of deep consumer habits in such an economy is analyzed. In the presented model, the formulation of deep habits differs from the generally accepted one, taking into account import in consumption. Secondly, different options for financing the growth of public spending are compared with each other. The role of deep habits in economic shocks is expressed in the inhibition of shifts in the household demand curve. For the first time, it is shown that deep habits lead to lower volatility of output and consumption and to higher volatility of inflation. The paper also shows that a prolonged shock to government spending creates a crowding-out effect in consumption and output, while a rapidly fading shock creates an accumulation effect. The medium-term increase in government spending considered in the paper, due to the subsequent need to balance the level of government debt, leads to a decrease in government consumption in the long term. According to two criteria (maximization of welfare and government consumption in the long term), the most preferable option for financing the growth of government spending is the use of a national fund invested in foreign assets or the external debt market.