Buffer-stock saving and the life cycle/permanent income hypothesis

  • Carroll C
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This paper argues that the typical household's saving is better described by a "buffer-stock" version than by the traditional version of the Life Cycle/Permanent Income Hypothesis (LC/PIH) model. Buffer-stock behavior emerges if consumers with important income uncertainty are sufficiently impatient. In the traditional model, consumption growth is determined solely by tastes. In contrast, buffer- stock consumers set average consumption growth equal to average labor income growth, regardless of tastes. The model can explain three empirical puzzles: the "consumption/income parallel" documented by Carroll and Summers; the "con- sumption/income divergence" first documented in the 1930s; and the stability of the household age/wealth profile over time despite the unpredictability of idiosyn- cratic wealth changes. I.

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  • Christopher D. Carroll

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