Habit persistence and the Harberger-Laursen-Metzler effect in an infinite horizon model

Abstract

The habit persistence model of Ryder and Heal is used to examine the Harberger-Laursen-Metzler (H-L-M) effect. Our results are in contrast to the general view in the literature that the stability requirements preclude the H-L-M effect in an infinite horizon model. We show that if the marginal utility of real consumption is strongly increasing in the habitual standard of living, then the H-L-M effect holds, and a terms of trade deterioration reduces savings. However, if the marginal utility of real consumption is not sufficiently strongly increasing (or is decreasing) in the habitual standard, then the H-L-M effect is overturned. © 1993.