Life Cycle Hypothesis Essay

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The Life Cycle Hypothesis’ (LCH) use of empirical findings bridges individual and national savings to the effects of fiscal and monetary policy, and macroeconomic wealth. The LCH presents an alternative approach to saving behavior. Individuals maximize the utility of their future consumption through consumption smoothing. Quintessentially, savings is a medium used to ensure a consistent standard of consumption in each stage of the life cycle. In a steady state a positive relationship exists between savings and capital. However, during business cycle fluctuations, for example, The Great Depression, “over saving” reduced consumption, and investment, creating excessive unemployment and low levels of output. In a postwar era, it was assumed…show more content…
The “stripped down” model has income and preference constraints, and no bequest. The implications in a stagnant economy defined by a lack of economic growth or population growth results in an unchanged rate of savings. However, in a steadily growing economy the national saving rate is consistent with life cycle behavior, and a higher aggregate saving rate in the long run. The article carefully makes the distinction between the causes of increased or positive saving rates, using the Neisser and Bentzel effects, growth due to population and productivity increases, respectively. Friedman found that productivity growth should decrease the savings ratio because a rise in permanent income would increase consumption relative to a rise in the income decreasing the savings ratio. However, Modigliani, found that if consumers planned with no anticipation of future consumption then wage and savings based on productivity growth would be the same. For example, in the United States during the 1960’s the savings ratio was primarily low because of low productivity and population growth rates. An amalgamated model or a less simplified one adds variables to the mix which influence savings, for example, a change in family size during the life cycle, bequests and labor supply (based on elasticity). The beauty of this model seems to be that its findings are true regardless of the variables that are thrown into the
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