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

Recent Declines in the Savings Rate 121
To avoid nonlinear estimation we approximate f(g) by a linear function and
write the private saving rate in the form:
PS ( Y - T)= a + bg + cGS ( Y -T)
(4.5a)
where c =-[1 - f(g)]l and [1 - f(g)] can be approximated by a constant. This
approximation is somewhat crude since 1 - f(g) is the consumption ratio which
varies appreciably in our sample, between 0.75 and 1.
In the case of the national saving ratio, which should be
NS Y = f ( g) ( 1-
T Y)+ d( GS Y)
= a+ bg- hT Y+ d( GS Y) where d = 1-( 1-( g)
) l
(4.5b)
Recently Barro [4] has proposed an extension of LCH according to which the
Sterling coefficient, l, must be unity. Clearly this conclusion would be consistent
with LCH if and only if life were of infinite duration. But he manages to reconcile
his claim with a finite life by postulating that the agent is so concerned
with the nature of his heirs that the life cycle relevant for the allocation of
resources extends beyond his own life to encompass that of his heirs, heirs of
heirs, etc. to infinity. Under these conditions the gain from a tax cut financed by
a deficit has to be totally saved in order to prevent the government from bringing
about a reshuffling of resources from the future lineage to the current generation.
This means that consumption and national saving will be totally unaffected
by the deficit.
There have been criticisms of Barro’s hypothesis or “Ricardian equivalence”
(because the hypothesis was first proposed, but also rejected, by Ricardo), a few
of which will be mentioned here.
(i) When the maximization of utility over all future generations calls for transferring
resources from future generations to the present, there is no way of enforcing
it. The actual allocation will then represent a corner solution, and a deficit
will provide the means for raising the utility of the current generation by increasing
current consumption at the expense of future consumption.
(ii) Similarly, with a corner solution due to credit rationing, a tax cut will be utilized,
at least in part, to increase consumption.
(iii) Asymmetries: a tax cut cannot have neutral effects as Barro supposes
because it redistributes wealth from current and prospective large families, who
are made worse off, to small families.
(iv) Implausibility: the evidence suggests that relatively few people at the top of
the distribution of wealth are concerned with bequests. My own estimate (1988)
is that the wealth received by bequest is only about 1/4 of the total. Also no