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

Utility Analysis and the Consumption Function 27
seriously biased measure of the accustomed level. In the previous test the extent
of this bias was measured by the correlation r yy-1 ; the higher the correlation, the
smaller the bias and, therefore, the higher the elasticity of consumption with
respect to income. Margaret Reid and a few others have suggested and tested
alternative methods of getting a more reliable index of the accustomed level than
current income and, invariably, it is found that when consumption is related to
such a measure, the elasticity of consumption with respect to it rises markedly
above the consumption-current income elasticity, and comes close, frequently
remarkably close, to unity. 46
Another set of results that supports our model is that reported in the classical
contribution of Dorothy S. Brady and Rose D. Friedman, “Savings and the
Income Distribution.” 47 As is well known, their major finding is that the saving
ratio appears to bear a much more stable relation to the position of the income
recipient in the income distribution than to the absolute level of income itself. In
other words, the proportion of income saved in a given decile varies much less
over time and space than the proportion of income saved at a given level of
income. It is not difficult to see that these results are what one would expect if
our model is correct. As should be clear from the reasoning we have followed in
developing our figure 1.2, the relative frequency of households in a given income
bracket whose income is below or above their accustomed level, depends, not on
the absolute level of income, but, rather, on the position of the income bracket
relative to the average income. For example, in a given income bracket, say
$10,000, we should expect to find a large proportion of people whose accustomed
level is less than $10,000 if, say, the average income is $2,000 and the level
$10,000 is in the top decile; while, in this same bracket, we should expect to find
a small proportion of people whose accustomed level is below $10,000 if the
community average income were, say, $50,000 so that the $10,000 bracket is in
the lowest income decile. More generally, it can be shown that provided, as seems
likely, there is a fairly stable relation between average income in a given decile
and the over-all average income, then the saving ratio, in a given decile, would
depend primarily on the (relative) short-term variability of income. 48 Thus, if we
compare, over time or space, groups for which the (relative) variability of income
is not very different, the proportion of income saved in any given decile should
be roughly the same for every group. As an example, we can compare the behavior
of nonfarm families in different regions and at different points in time (see
Brady and Friedman, charts 1 through 4) and we find our inference confirmed.
Furthermore, within a group, the greater the variability in income, the greater
should be the variation in the saving ratio as between the lower and the upper
deciles. This inference, too, is supported by comparison of nonfarm and farm
groups (compare chart 2 with chart 5).