Abstract: This paper tests for the presence of habit formation using urban household data from the China Health and Nutrition Survey. By conducting the system GMM estimations, we find strong evidence of habit formation on nondurables consumption and total consumption. The habit formation effect is important in explaining the high saving rates of urban households in China. This finding is robust even if we consider the precautionary saving motivation of urban household. Moreover, the marginal effect of habit formation on consumption is much larger than that of precautionary motivation. We also find that household wealth is positively related to the strength of habit formation effect.

Key words: Habit Formation, Precautionary Saving Motivation, System GMM