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

24 The Life-Cycle Hypothesis
consumption with respect to income should depend, according to our theory, on
three major factors which are capable of variation in different samples. This
elasticity depends, inversely, on (a) the degree of short-term variability of income;
(b) the magnitude of variations over time in the permanent component of income
that give rise to unbalances in the relation between assets holdings and the permanent
component itself; and (c) directly, on the elasticity of income expectations.
40 Given the magnitude of these three factors, the elasticity should depend
also on the age of the households in the sample since, as we see from equation
(II.1¢), the coefficient of the second and third components of p vary with age.
This point, however, will receive proper attention in the next section.
In our discussion so far we have been concerned with a cross section of households
within the earning span. The effect of the inclusion of retired households
in the sample can readily be established. According to our model, these households
should have, on the average, levels of consumption not very different from
the over-all average, 41 while, at the same time, earning incomes well below
average (in our present simplified version, no income at all). The inclusion of
these households, therefore, will have the effect of raising still further the c¯(y)
curves for low levels of y, thereby increasing its general tilting and possibly
making it convex to the income axis. 42
Summing up, the typical findings of budget studies as to the relation between
consumption, saving, and income in a given year, or some other short interval of
time, are precisely what they should be according to our model. But, as we see,
the interpretation of these findings that follows from our model is radically different
from the one generally accepted. According to the usual interpretation,
these findings show that the proportion of income saved rises with the economic
status of the household. According to our model, on the other hand, they only
show that households whose income is above the level to which they are adjusted
save an abnormally large proportion and those whose income is below this level
save an abnormally low proportion, or even dissave.
To be sure, up to this point, we have done little more than to show that the
findings of budget data are consistent with either interpretation. It may be
objected that this demonstration is an insufficient ground for discarding the old
and widely accepted explanation for our new and radically different one. It would
seem that, to support our claims, we should be able to produce some crucial tests,
the result of which will enable us to discriminate between the two competing
explanations. We believe that the remarkable piece of research recently reported
on by Margaret G. Reid, discussed in the next section, comes as close to providing
such a test as seems feasible with the kind of data that are presently
available. 43