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

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THE AGE-SAVING PROFILE AND THE LIFE-CYCLE HYPOTHESIS
Tullio Jappelli and Franco Modigliani
1 Introduction
The Life-Cycle Hypothesis posits that the main motivation for saving is to accumulate
resources for later expenditure and in particular to support consumption
at the habitual standard during retirement. According to the model, saving should
be positive for households in their working span and negative for the retired ones,
and wealth therefore should be hump-shaped (Modigliani 1986). Yet, if one looks
at the microeconomic evidence on household saving rates by age, dissaving by
the elderly is seldom observed.
To take just one example, in the introductory essay of a collection of country
studies on saving, Poterba (1994) reports that in virtually all nations the median
saving rate is positive well beyond retirement, concluding that “the country
studies provide very little evidence that supports the Life-Cycle model.” Based
on the country studies, Poterba also reports that the median saving rate in the age
class 70–74 is 1.1 percent in the United States and 6 percent in Canada; in Italy
and Japan for those aged 65 and older it is even higher.
These figures are inconsistent not only with the elementary version of the LCH,
but also with more elaborate versions. In its basic formulation, the LCH posits
that saving behavior is forward looking and driven by the desire to prepare for
future expenditures above later income throughout life. The main foreseeable
event it one’s life is old age and retirement. At this time earned income may be
expected, on average to dwindle to a level well below active life consumption.
This implies that an essential observable implication of the LCH is the existence
of phases of life—notably during the retirement period—when consumption
tends to exceed earned income financed by negative saving in the form of a reduction
in wealth accumulated in the earning span. Refinement of the standard model,
allowing for uncertainty, precautionary saving, and accidental bequests may
affect the age after which one should start observing wealth decumulation. It does
not, however, affect the main implication of the theory that individual wealth