Habit Persistence and Keeping Up with the Joneses:Evidence from Micro Data

Abstract

This paper provides evidence that habit persistence is an important determinant of household consumption choices, in a setting that allows for heterogeneity and household-specific interest rates. By estimating Euler equations for a representative sample of U.S. credit-card account holders, I find that the strength of external habit, captured by the fraction of the consumption of the reference group that enters the utility function, is 0.290, and that the strength of internal habit, represented by household past consumption, is 0.503. My results are robust to the inclusion of various measures of economic activity in the regression, tests for the presence of aggregate shocks, liquidity constraints, precautionary saving motives, and learning. Aggregation of the Euler equations as a weighted average of individual marginal rates of substitution accounts for heterogeneity and market incompleteness and preserves the results.