LIFE CYCLE, INDIVIDUAL THRIFT AND THE WEALTH OF NATIONS.pdf

LIFE CYCLE, INDIVIDUAL THRIFT AND THE WEALTH OF NATIONS FRANCO MODIGLIAN I Sloan School of Management, Massachusetts Institute of Technology, Cam- bridge, MA Introduction This paper provides a review of the theory of the determinants of individual and national thrift that has come to be known as the Life Cycle Hypothesis (LCH) of saving. Applications to some current policy issues are also discussed. Part I deals with the state of the art on the eve of the formulation of the LCH some 30 years ago. Part II sets forth the theoretical foundations of the model in its original formulation and later amendment, calling attention to various implications, distinctive to it and, sometimes, counter-intuitive. It also includes a review of a number of crucial empirical tests, both at the individual and the aggregate level. Part III reviews some applications of LCH to current policy issues, though only in sketchy fashion, as space constraints prevent fuller discussion. I. Antecedents ( 1) The role of thrift and the Keynesian revolution The study of individual thrift and aggregate saving and wealth has long been central to economics because national saving is the source of the supply of capital, a major factor of production controlling the productivity of labor and its growth over time. It is because of this relation between saving and produc- tive capital that thrift has traditionally been regarded