Liquidity Effects and Habit Persistence

Abstract

Abstract

            We introduce various types of habit persistence in consumption and leisure into a limited participation model to investigate whether these features can account for persistence in normal interest rate. We model this by assuming that the past levels of consumption and leisure affect the current utility of agents. We consider five different versions of a limited participation model, the benchmark model, the model with the habit persistence in only consumption, the model with the habit persistence in only leisure, the model with the habit persistence in both consumption and leisure and the model with the habit persistence in only consumption extended for more than one period. Our results show that depending on the nature and the duration of habit persistence, it was possible to generate varying degrees of serial correlation in normal interest rate movements.