Lifecycle Hypothesis - Explained
What is the Lifecycle Hypothesis?
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Table of ContentsWhat is the Life-Cycle Hypothesis?How did the Life-Cycle Hypothesis Develop?Academic Research on the Life-Cycle Hypothesis (LCH)
What is the Life-Cycle Hypothesis?
The Life-Cycle Hypothesis (LCH) refers to an economic theory which involves people's spending, as well as, saving habits over the course of a lifetime. Franco Modigliani and Richard Brumberg, his student, developed the concept.
LCH presumes that people plan their spending over their lifetime, considering their future income. Also, they pile up debt at a young age, supposing future income would make it possible for them to pay off the debt.
They then save during middle age so as to maintain their consumption level once they retire. This brings about a "hump-shaped" pattern whereby there is a low accumulation of wealth during youth, as well as, old age, and high during middle age.
How did the Life-Cycle Hypothesis Develop?
The Life Cycle Hypothesis replaced a previous hypothesis which economist John Maynard Keynes developed. His belief was that savings were just another good and that the percentage which people earmarked for savings would rise as their incomes increased.
This brought about a potential challenge in that it meant that as a nation's incomes rose, a savings glut would result, and aggregate demand and also economic output would remain stagnant. There has been a support to the Life Cycle Hypothesis from subsequent research.