Welfare Implications of the Interaction between Habits and Consumption Externalities


We analyze the welfare properties of the equilibrium path of a growth model where both habits and consumption externalities affect the utility of consumers. Our analysis highlights the crucial role played by complementarities between externalities and habits in order to generate an inefficient dynamic equilibrium. In particular, we show that the competitive equilibrium is inefficient when consumption externalities and habit adjusted consumption are not perfect substitutes.
Published as: Monetary policy and exchange rate volatility in a small open economy in Review of Economic Studies , Vol. 72, No. 3, 707-734, July, 2005