Habit formation and news-driven business cycles

Abstract

This paper demonstrates that, in a standard real business cycle (RBC) model, internal consumption habits alone are sufficient to generate positive comovements among key macroeconomic aggregates in response to news about future productivity. We highlight the prospective channel associated with internal habits, through which the effect of news shocks is transmitted to the present, stimulating current consumption, labor, and investment. Without this channel, other forms of preferences such as external habits fail to generate the positive comovements. The quantitative performance of the model is also discussed. Arguably, we provide a nearly minimal departure from the RBC framework to generate news-driven business cycles.