On the Growth and Stability Effects of Habit Formation and Durability in Consumption

This paper shows that a unique balanced growth monetary equilibrium exists in a transactions-based monetary endogenous growth model with habit formation or durability in consumption. An increase in the nominal money growth rate reduces the long-run output growth rate, wherein habit formation enforces the effectiveness of monetary policy while durability in consumption reduces it. We also show that while habit formation destabilizes the macroeconomy by making the balanced growth equilibrium exhibit local indeterminacy, durability in consumption maintains saddle-path stability of the balanced growth equilibrium. We find that the mechanism through which habit formation and durability impose different effects on both the growth-effect of money and the macroeconomic stabilizing properties is such that habit formation and durability influence the elasticity of intertemporal substitution in consumption in opposite directions.