Humps and bumps in lifetime consumption
There is much debate over whether the life-cycle model of consumption can explain consumption growth patterns patterns observed in household level data sources. We argue that once one departs from simple classroom example, or 'stripped down life-cycle model', the empirical model for consumption growth can be made flexible enough to fit the main features of the data. Using simulation techniques to assess the predictions of a life-cycle model estimated on US consumption data, we find that: Allowing demographic variables to affect household preferences and relaxing assumptions about the effects of uncertainty can generate hump-shaped consumption profiles over age that are very similar to those observed in household level data sources, without appealing to alternative explanations such as liquidity constraints, myopia or mental accounting. Humps in consumption paths are partly attributable to precautionary savings, and partly due to demographics; Bumps (or tracking - whereby consumption jumps with income) are instead due to the permanent nature of income shocks. Neglecting the effects of uncertainty produces consumption profiles that are 'too flat', whereas neglecting the effects of demographics generates consumption profiles that peak 'too late'.
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