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

The Age Saving Profile 143
It is obvious that the concept of cash income is not only irrelevant, but also
highly misleading. What comes to be subtracted and added from earned income
to arrive at disposable income has the effect of “flattening out” the original path
of the variables into an NIA path, which cuts off from the age profiles of earned
income, saving and wealth; the very humps the life cycle paradigm is all about.
In most developed countries, disposable and earned income can thus be
expected to exhibit a quite different life path. Using Italy as an example, we will
demonstrate these propositions. Italy is admittedly an extreme case with pension
contributions in excess of 30 percent and inordinately high replacement rates. But
the subtractions and additions are very large in developed countries, in particular
in Western Europe. It is not surprising, then, that the other authors find little
life cycle left in their NIA measure and that, using the correct measure of family
earnings, saving and wealth, the bumps return with a vengeance.
2 Definitions, Measurements, and Relation to Earlier Work
We implement appropriate definitions and measures of income and saving to
Italian repeated cross-sectional data. In particular, income will be measured as
earned income (labor plus property income) net of personal taxes. By subtracting
consumption we get the relevant measure of total family accumulation, which
we call total (household) saving. This quantity in turn can be broken down into
two components:
• Contributions to pension plans less pensions received, which for practical purposes
in Italy consist only in contributions to and from Social Security and are
therefore referred to as mandatory saving.
• The difference between total and mandated saving, which we label personal or
discretionary saving. This component coincides with the NIA “Personal Saving”
and with the concept erroneously used in earlier tests.
Central to our analysis is the proposition that (net) contributions to pension
plans are to be regarded as a component of total saving, because, like any
other type of life cycle saving, they constitute a portion of current income that is
not consumed, but used to build up reserves for later consumption. One might
challenge this point of view on the ground that true saving should result in an
increment in national wealth or capital. Yet, in many public pension systems—
notably those that rely on pay-as-you-go financing—there is no connection
between contributions and national saving. To answer this objection one must
understand the relation—and interaction—between various saving flows, private
and public.