Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis
This paper argues that the typical household's saving is better described by a 'buffer-stock' version than by the traditional version of the Life Cycle/Permanent Income Hypothesis (LC/PIH) model. Buffer-stock behavior emerges if consumers with important income uncertainty are sufficiently impatient. In the traditional model, consumption growth is determined solely by tastes. In contrast, buffer-stock consumers set average consumption growth equal to average labor income growth, regardless of tastes. The model can explain three empirical puzzles: the 'consumption/income parallel' documented by Carroll and Summers; the 'consumption/income divergence' first documented in the 1930s; and the stability of the household agewealth profile over time despite the unpredictability of idiosyncratic wealth changes. Copyright 1997, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
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Volume (Year): 112 (1997)
Issue (Month): 1 (February)
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