HABITS AND THE SAVINGS-GROWTH RELATIONSHIP Why US Personal Savings Rates Are At Historic Lows
In this paper we show that the solution to the standard consumer maximisation problem which is augmented by habit-persistence can imply a positive and linear relationship between changes in the level of savings and changes in present income. We show that these savings-income dynamics contrast with the orthodox view that the level of the savings rate is related to the present growth rate of income. The model also implies that if expectations of future changes in income are positive and present income itself is stationary, then the level of consumption tends to converge on income over time and savings fall. In these circumstances the standard model predicts that the level of savings and consumption remain constant. Using personal savings and disposable income time series data, we show that a simple bivariate version of the habits-augmented model which assumes constant expectations of future changes in income and strong habit persistence performs extremely well in terms of explaining the dynamics of post-war United States personal savings rates; in particular their recent decline to historic lows.
|Date of creation:||19 May 1999|
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