Modelling Deep Habits in Iranian Economy using a Markov-Switching DSGE Model

Abstract

This paper attempts to solve and estimate a Markov-Switching Dynamic Stochastic General Equilibrium (MS-DSGE) model with deep habit-adjusted consumption in both private and public sectors for Iranian data from 1991 to 2015. A comprehensive New Keynesian Philips Curve (NKPC) is also extracted, including stock of private and public habit consumption in firm's profit maximization problem as a constraint. The model is estimated both with constant parameters and regime switching in monetary reaction function, and it is concluded that the model with regime switching is able to fit the Iranian data better. The results of estimating parameters indicate that the degree of habit formation, together with the persistence of habit stock, are significant parameters. However, it is shown that deep habits do not succeed in reducing inflation in Iranian economy in reaction to a monetary shock. The results confirm that consumption increases and inflation decreases, simultaneously in response to fiscal shocks.