Life-Cycle Hypothesis Of Saving Analysis

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In this study the attention has been drawn to the article "The life-cycle hypothesis of saving, the demand for wealth and the supply of capital", written by Modigliani (1966). In addition to the life-cycle hypothesis of saving, the precautionary saving theory, permanent income hypothesis, habit formation and the theory of the Ricardian Equivalence are discussed. The aim is to present the basic conditions of these models in order to get a deeper understanding of the complex relationship between private savings and its determinants. 3.1 The Life-Cycle Hypothesis of Saving The central motive for saving in the life-cycle model is the accumulated savings for retirement. In addition to this, the life-cycle model deals with consumption-saving decisions…show more content…
Leland (1968) and Sandmo (1970) consider a two period model of consumption, which is the same approach used in the Life-cycle model by Modigliani (1966). One can assume that the uncertainty that the future brings might affected private savings behavior. If individuals strive to achieve a steady flow of consumption over their life-cycle, but lack information about future income, saving will be adjusted according to expectations about real…show more content…
Households plan their economic behavior based on their expectations of government action. For example, if the government implements an expansionary fiscal policy, which involves large tax cuts financed by borrowed funds, households will not take advantage of the increase in disposable income that this brings and use it for consumption. It is presumed that households are aware of the fact that the actions made by the government are financed through loans and they interpret that the increase in public debt will culminate in an increased future tax expense. In addition to this, households are presumed to increase their savings in proportion to the governments’ debt and the effects associated with expansionary fiscal policy are often become absent. For example, government deficits are irrelevant to the level of private savings, since increases in private savings will counteract government budget deficits. If the Ricardian Equivalence holds, private savings will increase when public savings decrease (Barro,

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