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

26 The Life-Cycle Hypothesis
as an indirect, approximate measure of the degree to which the current income
of each household is close to the level to which the household is adjusted (or to
a constant multiple of this level—see previous paragraph). In the first place, this
correlation is a very good direct measure of strictly short-term fluctuations which,
as we have seen, control the relation between ȳ e (y) and y. Secondly, it seems reasonable
to expect that the gap between p¯(y) and ȳ e (y) will, itself, tend to be smaller
the smaller the short-run variability of income; for, when incomes are basically
stable, there should also be less opportunity for significant discrepancies between
the permanent component of income and assets to develop. Thus, when the
correlation between current and previous income is high, p¯(y) itself should
tend to be close to y. The p¯(y) and c¯(y) curves should, therefore, be similar to
those of figure 1.1, and the elasticity of consumption with respect to income
should be close to unity. Conversely, when the correlation between current and
previous income is small, evidencing the presence of pronounced short-term
fluctuations, the ȳ e (y), p¯(y), and c¯(y) curves should be similar to those shown in
figure 1.2, and the elasticity of consumption with respect to income should be
well below unity.
Hence, if we take several samples of households and, for each of these samples,
we compute (a) the correlation between current and previous income, r yy-1 and
(b) the elasticity of consumption with respect to income, we should find a clear
positive rank correlation between the two above-mentioned statistics and, furthermore,
h cy should approach unity as r yy-1 approaches unity. In essence, this is
precisely the test Reid has carried out and her results clearly confirm our inference.
The fact that for none of her groups r yy-1 is, or could be expected to be, as
high as unity prevents h cy from ever reaching the theoretical stationary value of
unity; but her data do show that, in the few cases where r comes close to one,
h cy is also impressively close to unity. According to Reid’s results h cy ranges from
a value as low as .1 for r in the order of .2 to values as high as .8 for the highest
values of r, which are in the order of .8. 45
The above discussion is, of course, not intended as an exhaustive account of
Reid’s techniques and many valuable results; for this purpose the reader is
referred to her forthcoming publications. Nevertheless, the brief sketch presented
should be sufficient to indicate why her results seem to us to represent as impressive
a confirmation of one important implication of our theory, at the microeconomic
level, as one may hope to find at this time.
In addition to the test just described, there are several other, partly older, findings
that support our model and acquire new meaning in the light of it.
According to our model the typical findings of budget studies as to the relation
between consumption and income are basically due to the fact that, in the
presence of short-term fluctuations, income over a short interval is a poor and