Many studies have proved that a model with habit formation can well capture consumers’ responses to monetary policy and thus serves as a better platform for monetary policy analyses. However, most studies on monetary policy of Taiwan neglect habit formation. The goal of this paper is to verify the behavior of habit formation in consumption in Taiwan with the generalized methods of moments (GMM). Following Leith and Malley (2005), we develop a dynamic stochastic general equilibrium (DSGE) model in a closed economy and find that habit formation behavior is significant in Taiwan. The results from GMM estimation are as follows. The estimated value of habit persistence is 0.934, accord with that of other countries. Households would spend about 4 years to set the new wage contracts. Furthermore, it takes about 4.5 years for firms to reset the new price.

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