"Expanding the Life-Cycle Model: Precautionary Saving and Public Policy"
American Economic Review,
Volume: 84 | Issue: 2 | Pages: 174-79
Publication type: Journal article
Research Archive Topic: Business Economics and Public Policy
In this paper, the author outlines what he believes to be causes of why many people do not save. Much of the research examining levels of consumption, saving, and wealth, as well as their responsiveness to policy, has been done using a life-cycle model with the simplifying assumption of perfect certainty. More recently, a line of inquiry has examined the effects of uncertainty on saving, generally in the context of highly stylized models. This research has shown that, in these models, uninsured earnings uncertainty can alter optimal saving behavior in a variety of important ways. The perfect-markets version of the life-cycle model has directly or indirectly contributed much of the intuition about effects of public policies on household saving decisions. While the findings of the research project cast doubt on the applicability of the standard, perfect-certainty version of the life-cycle model for policy analysis, it is concluded that a well-specified optimizing life-cycle model with uninsured idiosyncratic risks and social insurance can explain many empirical observations, including the saving behavior of much of the population. It is therefore likely to be a useful tool for analyzing the effects of government policy on saving behavior.
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