Mauro Bambi

This paper develops a parsimonious model of habit formation in leisure and studies its implications for labour market participation. Leisure habits introduce non-concavities in the instantaneous utility function and can generate multiple steady states and complex dynamics, making the identification of optimal policies non-trivial. To address this issue, we combine the Pontryagin maximum principle, dynamic programming, and numerical phase-diagram analysis to select the unique globally optimal trajectory. We, then, use our results to study the effects of a temporary, exogenous cap on labour market participation, motivated by lockdown policies, and show that, for a reasonable choice of parameters, the implied speed of return to the pre-shock steady state aligns closely with the data.