Relative Consumption Benchmarks

Consumption benchmarks, of both the internal and external types, have recently moved beyond the realm of asset pricing models and been applied in other macroeconomic settings.1 Ljungqvist and Uhlig (2000) study the role of consumption externalities in setting the optimal labor tax rate. Uribe (2002) shows that internal habit persistence in consumption goes a long way towards explaining observed dynamics of terms-of-trade and consumption following exchange-rate-based stabilization programs. Fuhrer (2000), also using a model featuring internal habit persistence, shows that habits have implications for the transmission mechanism of monetary policy. These are but a very few of the papers in recent years that have successfully used consumption benchmarks to explain various macroeconomic phenomena. While each of these authors shows that consumption benchmarks are useful in solving some puzzle, they all introduce benchmarks into the representative agent’s utility function in a specific way, either in an additive form (for example, Ljungvist and Uhlig (2000) and Uribe (2002)) or in a multiplicative form (for example, Fuhrer (2000)). Dupor and Liu (2003) make an interesting but as-yet little-exploited contribution to the evolving discussion on consumption externalities in macroeconomics by identifying two distinct aspects of such externalities. By disentangling the concepts of jealousy/admiration and keeping-up-withthe-Joneses/running-away-from-the-Joneses (KUJ/RAJ), they provide researchers interested in the effects of consumption externalities general tools to use. Before proceeding, I offer a more general intuitive interpretation of the concepts KUJ and RAJ than in Dupor and Liu (2003). Simply put, KUJ is a desire to be similar to others, while RAJ is a desire to be different from others. The phrase “keeping up” suggests that individuals are always struggling to increase their consumption to match that of some reference group. However, “keeping down with the Joneses” seems a perfectly well-defined notion as well. Frank (1999) anecdotally discusses how he once refrained from purchasing a showy car only because his neighbors owned ∗E-mail address: [email protected]. I thank an anonymous referee for useful comments and, at an early stage