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

Recent Declines in the Savings Rate 115
finite and structured, and that, therefore, income and consumption exhibit in addition
to random shocks also systematic variations arising from the life cycle characterized
by the succession of a preworking, a working, and a retired phase. LCH
is thus in a position to explore the implications not only of random shocks, which
are basically the same as for PY, but also of systematic life cycle variations of
saving and wealth. These turn out to be crucial for an understanding of aggregate
saving whereas the variations of transitory income are not too relevant since
under aggregation they tend to cancel out. Not surprisingly therefore, PY, in contrast
to LCH, has little to say about aggregate consumption and saving. In what
follows we concentrate on the aggregate implications of LCH, since they are the
ones that are relevant for the study of the recent drying up of saving.
1.3 The Aggregative Implications of LCH: The Basic Model
To understand the implication of LCH it is useful to rely on two successive
approximations. In the first approximation, or basic model, it is assumed that there
are no bequests and there is no government—or at least no unbalanced budget.
In addition, we rely on one basic assumption about the nature of allocation preferences,
namely that behavior can be described as though the representative agent
had a homothetic preference map, stable over time (meaning that the ratio of preferred
consumption at any age to life resources is independent of the size of life
resources).
1.3.1 The Role of Income Growth
From these assumptions one can establish the following propositions
(Modigliani-Brumberg [15]): 1) the saving rate of a country is independent of its
per capita income; 2) two countries may have different rates of saving even
though individuals are equally thrifty, in the sense of having the same life path
saving and wealth; 3) the saving rate depends critically on the rate of growth in
the following sense: (i) with zero growth, the saving will be zero, regardless of
income or thrift habits, (ii) there can be saving only when there is growth and
between economies with equal thrift, the one with the fastest growth can be
expected to save the most; 4) an economy can accumulate a very substantial stock
of wealth relative to income, even in the absence of bequests.
These propositions are the most elementary example of life cycle model in
which income is constant through the earning span, zero thereafter, and consumption
is constant through life and national income is stationary. In this case
there will be saving till retirement, and dissaving after retirement equal to the
amount accumulated till then. It should be clear that, in this economy, the wealthincome
ratio is independent of income, national or per capita; it can also be
readily shown that it is equal to half the number of retired years. For this simple