Deep Habits in New Keynesian model with durable goods

Empirical evidence for the United States suggests that private consumption of durable and nondurable goods have a positive response to government spending shocks. Moreover, the markups for both goodstend be procyclical on productivity shocks and countercyclical on demand shocks.These facts contrast with the results obtained from standard two-sector New Keynesian models with perfect financial markets. In this paper we address these shortcomings by introducing habit formation on the consumption of bothdurable and nondurable goods. Habit formation on differentiated goods - i.e. Deep Habits - proves to significantly alter the dynamics of the model. However, the effects from habits on durable goods are only meaningful when defined over purchases rather than stocks. When we introduce capital formation into the model, it continues to be consistent with the responses observed in the data.