I was glad that James discussed a bunch of the literature that uses habits and habit persistence yesterday. I have run into the idea of habit persistence in consumption before while doing macroeconomic modeling, and it was good to see him bring it back to the observed phenomenon of reference dependence in individuals – as I stated, I wasn’t looking for ideas of how to model it directly, more an understanding of “what a habit is in the choice theoretic context”.
Reference dependence does explain a lot of the “why” I was looking for, as does “limited cognitive capacity”. I think we still need to ask exactly how these processes work though.
And that is why reference dependence does not quite fully cover it off for me – undoubtedly because I am being fussy. And this comes back to the logic behind why I decided to suggest “a choice of investment in a stock of habit” rather than just suggesting “that habits are described by a state variable that is a function of past action”.
What I really want to know is three-fold:
- What is the initial endowment of human habits,
- Can choices now relate to habits in the future in a purposeful way,
- The Lucas critique – but applied to habits.
Treating a habit like a preference (which is what much of the literature implicitly does) might be sufficient – but I do not believe so. And that is because I think that many people “choose” to build habits and rules of thumb explicitly, given the underlying endowments and social situation around them.
This is a very important issue when we actually come to look at policy, for example:
- If habit formation adjusts to monetary policy settings that assume it, and we have put it in as a constant (eg rule of thumb consumer) then our settings will be inappropriate.
- In terms of time inconsistency, the development of habits can be seen as investment into an optimal “time consistent” path to improve outcomes.
My question isn’t “do habits exist” or “do we model habits”. It is “are we currently modeling the development of habits in a way that is consistent with methodological individualism – that is consistent with individuals that make choice”. Merely assuming an exogenous preference, doesn’t do this.