Tejvan Pettinger

The Life-cycle hypothesis was developed by Franco Modigliani in 1957. The theory states that individuals seek to smooth consumption over the course of a lifetime – borrowing in times of low-income and saving during periods of high income.


Graph shows individuals save from 20 to 65

It suggests wealth will build up in working age, but then fall in retirement

Wealth in the Life-Cycle Hypothesis

The theory states consumption will be a function of wealth, expected lifetime earnings and the number of years until retirement.

Consumption will depend on

It suggests for the whole economy consumption will be a function of both wealth and income.

The implication is that if we have an ageing population, with more people in retirement, then wealth/savings in the economy will be run down.

Prior to life-cycle theories, it was assumed that consumption was a function of income. For example, the Keynesian consumption function. saw a more direct link between income and spending.

However, this failed to account for how consumption may vary depending on the position in life-cycle.

Motivation for life-cycle consumption patterns

Does the Life-cycle theory happen in reality?

Mervyn King suggests life-cycle consumption patterns can be found in approx 75% of the population. However, 20-25% don’t plan in the long term. (NBER paper on economics of saving)

Reasons for why people don’t smooth consumption over a lifetime.

Criticisms of Life Cycle Theory

Other theories

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