Template-Type: ReDIF-Paper 1.0

Author-Name: Mikhail Andreyev
Author-Email: andreevmyu@cbr.ru
Author-Workplace-Name: Bank of Russia, Russian Federation

Title: Deep habits and financing of government expenditure growth

Abstract: This paper uses a stochastic general equilibrium model for a small open export-oriented economy to address 
two key issues. First, it analyses the impact of deep habits in such an economy. Habits refer to consumers’ tendency 
to maintain a consumption level similar to previous periods, while deep habits indicate a tendency related to each 
consumed good rather than just the overall consumption level. We present a model in which the formulation of deep habits 
differs from the conventional one, taking into account imports in consumption. Second, we compare different financing 
options for growth in government spending.

The role of deep habits in response to economic shocks is reflected in the dampening of shifts in the household demand 
curve. The paper is the first to show that deep habits lead to lower volatility in output and consumption and to higher
volatility in inflation. It also demonstrates that a long-lasting government spending shock results in a crowding-out 
effect on consumption and output, while a temporary shock leads to an accumulation effect.

The medium-term increase in government spending (and government consumption1) examined in this study, due to the subsequent
need to balance public debt levels, results in decreasing government consumption in the long term. Based on two criteria 
(maximising welfare and government consumption in the long term), the most preferred financing options for growth 
in expenditure are the use of a national fund invested in foreign assets or the external debt market.

A key innovation of the study is the application of the concept of deep habits to an exporting economy where imports 
play a significant role in consumer demand; the differentiation between temporary and long-lasting government spending 
shocks; and the analysis of various financing options for public spending growth, which, as shown, influences 
the manifestation of either the accumulation or crowding-out effect.

Length: 34 pages
Creation-Date: 2024-10
Revision-Date:
Publication-Status:
File-URL: https://www.cbr.ru/StaticHtml/File/170515/wp_134.pdf
File-Format: Application/pdf
File-Function:
Number: wps134
Classification-JEL: D58, E47, E62, E63
Keywords: dynamic models, rational expectations, fiscal policy, habits, fiscal expansion, crowding-out effect
Handle:RePEc:bkr:wpaper: wps134