Deep Habits, Rule-of-Thumb Consumers, and Fiscal Policy

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 rule-of-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 rule-of-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.