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

Utility Analysis and the Consumption Function 29
derived so far from our theory and which is not equally consistent or, at any rate,
readily explainable in terms of any other single set of hypotheses that, to our
knowledge, has been advanced so far.
II.5
Individual Saving, Assets, and Age
In recent years a good deal of attention has been devoted to the influence of assets
on consumption, and attempts have been made at estimating the cross-section
relation between these variables on the expectation that the parameters obtained
would yield information on the time-series relation. Our theory has something to
contribute as to the pitfalls of such an attempt. To begin with, it suggests that the
relevant concept of assets is net worth; unfortunately, most of the recent empirical
work has concentrated instead on liquid assets, a variable which, according
to our model, bears no definite relation to consumption, except perhaps as a very
imperfect proxy for net worth.
But even if information on net worth were available, knowledge of the variation
in consumption as between different households having different asset holdings,
would give very little (and that little would be biased) information as to how
a household would react if its assets were increased unexpectedly by a given
amount, say, by an anonymous gift of the usual benevolent millionaire or, to take
a more fashionable example, by an unexpected fall in the price level of consumables.
This failing occurs because the observed asset holdings do not just happen
to be there; instead, they reflect the life plan of the individual, which in turn
depends on income and income expectations.
To interpret the positive correlation between assets and consumption as implying
that people consume more because they have more assets would be only
slightly less inaccurate than the inverse inference that people have higher assets
because they consume more. The point is that both consumption and assets are
greatly affected by the other variables: income, income expectations, 52 and age.
It may be objected that we are destroying a straw man; anyone studying the
effect of assets would have sense enough to control the effect of, say, income.
This may well be true, yet we feel that the above paragraph contains a useful
lesson as to the relation between assets and consumption plans that one may too
easily forget. For instance, the statement which has been repeated ad nauseam
that in the early postwar years people bought durable goods lavishly because they
had such large holdings of liquid assets (which may even find some apparent confirmation
in survey results) might well stand a good deal of re-examination along
the lines indicated above.
But our model tells us that it is not enough to control income or even income
expectations. As it is brought out clearly by our analysis of the stationary case,
assets depend also on age (see equation II.8); and this implication of our model