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Federal Reserve Bank of Minneapolis
Staff Report
Habit persistence, asset returns and the business cycle
Michele Boldrin
Lawrence J. Christiano
Jonas D. M. Fisher
Abstract

We introduce two modifications into the standard real business cycle model: habit persistence preferences and limitations on intersectoral factor mobility. The resulting model is consistent with the observed mean equity premium, mean risk free rate and Sharpe ratio on equity. The model does roughly as well as the standard real business cycle model with respect to standard measures. On four other dimensions its business cycle implications represent a substantial improvement. It accounts for (i) persistence in output, (ii) the observation that employment across different sectors moves together over the business cycle, (iii) the evidence of ‘excess sensitivity’ of consumption growth to output growth, and (iv) the ‘inverted leading indicator property of interest rates,’ that high interest rates are negatively correlated with future output.


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Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, Habit persistence, asset returns and the business cycle, Federal Reserve Bank of Minneapolis, Staff Report 280, 2000.
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Keywords: Business cycles - Econometric models ; Monetary policy
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Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

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