Clarifying my question on habits

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:

  1. What is the initial endowment of human habits,
  2. Can choices now relate to habits in the future in a purposeful way,
  3. 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:

  1. 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.
  2. 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.

    1. If there is an exogenous preference for habitual behaviours then people will endogenously choose to invest in some habits, depending on how much they enjoy that activity. I think you’re drawing a false dichotomy between modelling it as a preference and choosing to form a habit.
    2. I don’t think Lucas was asking macroeconomists to explicitly model preference formation 😉

     

    • “I think you’re drawing a false dichotomy between modelling it as a preference and choosing to form a habit.”

       

      I would say that it is a matter of what is done – it is currently modeled as an exogenous process, or the endogenous process that generates it is arbitrary.

      Now when we solve models that include habitual behaviour in consumption, our agents solve forward and take this into account – that is cool.  But given that this forms part of what an agent is choosing to do, there is definitely a role to more accurately describing the process of habit formation … as the shape of this process will change the solution that our agents choose.

      “I don’t think Lucas was asking macroeconomists to explicitly model preference formation”

      No, but the reason it might be nice to have a firmer theory on the process of habit formation is that it allows us to model structural changes in the development of habits.

       

      • If I understand you correctly you’re saying “Economists should endogenously model preference formation.” Well, yes, that would be nice and there’s probably a Nobel prize waiting for whoever manages to find a convincing way of doing it.

        • I’m merely suggesting that more explicit modeling of habit formation is a good way forward – that would tie together a lot of disparate literature in economics.

          Even if we viewed habit strictly as a preference, saying that we should focus strongly at looking at one particular preference that is of great importance is very different to saying “lets model all the preferences”. … it is like admitting that the shift in some curves when we look at a market may in fact be of more consequence than the movements along the curves we focus on.

          On that slight side note – this is my current opinion about endogenous money people, they are talking about the importance of some shifts in curves in the credit market, and how to identify them.  If they communicated it in that way, they would find themselves well inside the mainstream.  So I don’t think it hurts us to pick things that are important and focus heavily on them 😉

        • I see a PhD topic…

        • For a smart person.  If we can find one we could suggest it to them.