Exchange Rate and Current Account Dynamics with Habits over Consumption and Money Holdings


Incorporating two independent habits over consumption and money holdings into a small country model, we examine the adjustment dynamics of the current account and the exchange rate to expansionary monetary and fiscal shocks under two alternative policy regimes: (1) the endogenous income transfer regime; and (2) the endogenous fiscal spending regime. In response to the shocks under regime (1), the exchange rate depreciates on impact and in the long run whereas it appreciates (depreciates) in transition if preferences for real money balances exhibit distant (adjacent) complementarity. Under regime (2), the consumption habits and the monetary habits jointly generate possibly non-monotonic current account dynamics. An induced increase in fiscal spending in regime (2) can generate a current account surplus in the case where the monetary habits exhibit strong distant complementarity.

Share and Cite:

I. Gombi and S. Ikeda, "Exchange Rate and Current Account Dynamics with Habits over Consumption and Money Holdings," Modern Economy, Vol. 4 No. 7, 2013, pp. 471-481. doi: 10.4236/me.2013.47051.

Conflicts of Interest

The authors declare no conflicts of interest.


[1] M. Obstfeld, “Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation,” Journal of Political Economy, Vol. 89, No. 6, 1981, pp. 1142-1161. doi:10.1086/261026
[2] A. Mansoorian, “On the Macroeconomic Policy Implications of Habit Persistence,” Journal of Money, Credit, and Banking, Vol. 28, No. 1, 1996, pp. 119-129. doi:10.2307/2077970
[3] A. Mansoorian and S. Neaime, “Durable Goods, Habits, Time Preference, and Exchange Rates,” The North American Journal of Economics and Finance, Vol. 14, No. 1, 2003, pp. 115-130. doi:10.1016/S1062-9408(02)00115-8
[4] S. Shi, “Weakly Nonseparable Preference and Distortionary Taxes in a Small Open Economy,” International Economic Review, Vol. 35, 1994, pp. 411-428. doi:10.2307/2527061
[5] S. Ikeda, “Export-and Import-Specific Habit Formation,” Review of Development Economics, Vol. 13, No. 4, 2009, pp. 709-718. doi:10.1111/j.1467-9361.2009.00525.x
[6] G. Constantinides, “Habit Formation: A Resolution of the Equity Premium Puzzle,” Journal of Political Economy, Vol. 98, No. 3, 1990, pp. 519-543. doi:10.1086/261693
[7] J. Y. Campbell and J. H. Cochrane, “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior,” Journal of Political Economy, Vol. 107, No. 2, 1999, pp. 205-251. doi:10.1086/250059
[8] C. D. Carroll, J. Overland and D. N. Weil, “Saving and Growth with Habit Formation,” American Economic Review, Vol. 90, No. 3, 2000, pp. 341-355. doi:10.1257/aer.90.3.341
[9] A. Daz, J. Pijoan-Mas and J. Ros-Rull, “Precautionary Savings and Wealth Distribution under Habit Formation Preferences,” Journal of Monetary Economics, Vol. 50, No. 6, 2003, pp. 1257-1291. doi:10.1016/S0304-3932(03)00078-3
[10] A. Mansoorian, “Habit Persistence and the Harberger-Laursen-Metzler Effect in an Infinite Horizon Model,” Journal of International Economics, Vol. 34, No. 1-2, 1993, pp. 153-166. doi:10.1016/0022-1996(93)90071-5
[11] S. Shi and L. G. Epstein, “Habits and Time Preference,” International Economic Review, Vol. 34, No. 1, 1993, pp. 61-84. doi:10.2307/2526950
[12] H. E. Ryder and G. M. Heal, “Optimal Growth with Intertemporally Dependent Preference,” Review of Economic Studies, Vol. 40, No. 1, 1973, pp. 1-33. doi:10.2307/2296736
[13] I. Gombi and S. Ikeda, “Macroeconomic Policy, Current Accounts, and Exchange Rate Dynamics with Habit Formation,” Unpublished (Available upon Request), 2012.
[14] J. W. Gruber, “A Present Value Test of Habits and the Current Account,” Journal of Monetary Economics, Vol. 51, No. 7, 2004, pp. 1495-1507. doi:10.1016/j.jmoneco.2003.12.004
[15] S. Ikeda and I. Gombi, “Habits, Costly Investment, and Current Account Dynamics,” Journal of International Economics, Vol. 49, No. 2, 1999, pp. 363-384. doi:10.1016/S0022-1996(98)00067-1
[16] M. Obstfeld and K. Rogoff, “Foundations of International Macroeconomics,” MIT Press, Cambridge Mass, 1996.
[17] S. Ikeda and I. Gombi, “Habit Formation in an Interdependent World Economy,” Macroeconomic Dynamics, Vol. 13, No. 4, 2009, pp. 477-492. doi:10.1017/S1365100509080183

Copyright © 2023 by authors and Scientific Research Publishing Inc.

Creative Commons License

This work and the related PDF file are licensed under a Creative Commons Attribution 4.0 International License.