Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis

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 contract 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 of Carroll and Summers [1991]; the consumption/income divergence first documented in the 1930's; and the temporal stability of the household age/wealth profile despite the unpredictability of idiosyncratic wealth changes