"Life Cycle" Hypothesis of Saving: Aggregate ... - Arabictrader.com

Recent Declines in the Savings Rate 111
of 16.6 percent in the sixties to 15.3 percent in the seventies, and finally crumbled
to 10.3 percent in the eighties, an overall decline of some 40 percent in
twenty years and of one-third in the last decade. What makes the episode even
more impressive is the generalized nature of the decline in saving. This can be
seen from table 4.2, which reports the change in saving between decades: the top
portion gives the change between the ’60s and the ’80s, the lower panel the
change from the decade of the 1970s to that of the ’80s. From the top panel we
see that saving fell in every single country (except Portugal where there was no
change). In the final period, from the ’70s to the ’80s, the decline again spread
to very nearly all countries, with the exception of Switzerland where the change
was again near zero, and Norway where it reflected unusual circumstances.
In the case of private saving, the decline, though still notable (from 14.8 percent
to 12.3 percent), is less dramatic and less widespread; over the entire period
saving declines in 16 countries out of 21, and only one of the remaining five has
a pronounced rise in saving. As will be shown presently, the difference between
the national and private saving rate reflects of course the large decrease in government
surplus, averaging nearly four percentage points.
1.2 A Brief Review of the Life Cycle Model Relevant to Aggregate
Saving
The so-called New Theories of the Consumption Function, which include the
LCH first developed by Modigliani and Brumberg [15], and the Permament
Income Hypothesis (PY) of Milton Friedman [7], are distinguishable from the
preexisting Keynesian model, based on crude empiricism, because they rest on a
choice theoretic framework and more precisely on the theory of optimum allocation
of “income” between alternative “commodities” (theory of consumers’
choice). Following the pioneering work of Irving Fisher, the commodities
between which the consumer chooses can be identified as consumption at various
points of life, and income with the (present value of) resources accruing over life.
This formulation has the basic implication that, contrary to the prevailing view,
consumption at any point in time, as well as over the lifetime, depends on life
resources and not on income at the time of consumption. Thus saving represents
the residual between the consumption optimally allocated to a period and whatever
the income happens to be in that period.
The essential difference between PY and LCH is that Friedman relies on the
approximation that life is infinite and therefore uniform. Friedman’s permanent
income is the present value of resources over the infinite life times the rate of
return, and his main concern is the effect, on the saving of individuals or groups,
of random shocks to income away from permanent income, his so-called transitory
income. The LCH on the other hand takes explicitly into account that life is