SERIE RESEARCH mEmORflnDH

The purpose of the paper is to extend recent results of Muellbauer (1986) for the life cycle consumption model under rational habit formation. It is shown that a general pattern of habits will lead to an arbitrary autoregressive integrated moving average (ARIMA) process for consumption. As a special case it is shown how a model in annual differences can be obtained by imposing a specific structure on the preferences. In the empirical part we analyze the model for quarterly seasonally unadjusted data on consumption for the Netherlands. The empirical evidence suggests the presence of rational habit formation. Helpful comments of Herman Bierens and stimulating discussions with Rob Alessie and Franz Palm are gratefully acknowledged. * Department of Economics and Econometrics, Free University, P.O. Box 7161, 1007 MC Amsterdam, Netherlands.