Credit and Habit Modification in the USA: 1959-1997

Since Brown (1952), habit formation models of consumption have assumed that memory loss is a univariate process. This paper dispenses with this assumption to consider habit modification in consumption. A model is proposed where household credit depletes the habit stock and motivates consumers towards a more forward-looking behaviour. The Johansen (1988) and Gregory and Hansen (1996) procedures are applied to test the hypothesis using U.S. data. Consistent withthe theory, the evidence presented shows that both household and consumer credit cointegrate with consumption expenditure and disposable income. Further, the long-run relationship has been subject to a structural break in 1987.