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

138 The Life-Cycle Hypothesis
disagreement about the direction of the effect. We have not included them in the
tests of table 4.3 because we do not regard these variables as quantitatively important
and we were eager to conserve degrees of freedom. We do not expect the
interest rate to be very important because we believe in a strong income effect,
reflecting the high wealth income ratio. As for the inflation, aside from the role
of the inflation adjustment on government interest which has been included, its
effect is the uncertain outcome of two opposing effects. On the one hand inflation
typically increases uncertainty and that generally makes for more saving. But
on the other the uncertainty of the return from saving discourages saving; and
inflation illusion, other than through government interest or some other variables
might also make for lower saving. Nevertheless, before concluding, we will summarize
the results of some rudimentary tests whose purpose is to make sure that
the inclusion of those variables would not prove to be of major significance or
radically change the results of table 4.3.
In the first test we added interest rate and inflation to line 4 of table 4.3. In the
case of inflation the coefficient is fairly significant (t-ratio of 2.4), but rather
small; an increase in inflation by one percentage point would decrease the saving
rate by 0.3 points. For the interest rate the estimate is even more negative (-0.7).
This is puzzling, considering that this coefficient should measure the substitution
effect since the income effect is included in the income term. Now the substitution
effect should, without question, be positive. However the coefficient of
interest is not significant (at the one percent level). Furthermore, when the same
variables are added to line 5, in which all variables are weighted by population,
the coefficient falls sharply, down to near zero. On the other hand, the coefficient
of inflation becomes more negative (-0.60) and more significant (t-ratio = 2.9).
The other coefficients of the equation are largely unaffected. Similar results are
obtained in tests using one variable at a time. The inflation effect is always
negative, and become especially significant in the weighted form (-0.6, t-ratio
of 3). However, the interest effect remains negative in the unweighted form but
in the weighted form it turns positive, though not significant.
This admittedly crude experiment supports the conclusion that neither the
interest rate nor the inflation are to be regarded as important contributors to the
determination of saving, although inflation appears to have but a mildly negative
impact, but mild at best. As for interest rate, though we cannot reject the hypothesis
that the substitution effect has the expected sign we can say that, in any
event, it appears to be small enough so that the total effect of a rise in interest in
positive on consumption and negative on saving.
In concluding it may be useful to summarize our results by comparing them
briefly with those reported in a recent study by Bosworth (1988). He has tested
a model similar to the one underlying our table 4.3 but using time series data for