Franco Modigliani and the Life Cycle Theory of Consumption
22 Pages Posted: 12 Apr 2005
Date Written: March 2005
In the early 1950s, Franco Modigliani and his student Richard Brumberg worked out a theory of spending based on the idea that people make intelligent choices about how much they want to spend at each age, limited only by the resources available over their lives. By building up and running down assets, working people can make provision for their retirement, and more generally, tailor their consumption patterns to their needs at different ages, independently of their incomes at each age. This simple theory leads to important and non-obvious predictions about the economy as a whole, that national saving depends on the rate of growth of national income, not its level, and that the level of wealth in the economy bears a simple relation to the length of the retirement span. These predictions, which were untestable in the 1950s, have received empirical support in later work by Modigliani and other researchers. While there have been many challenges to the theory of consumption through the years, most recently from a coalition of psychologists and economists, the life-cycle hypothesis remains an essential part of economists' thinking. Without it, we would have much less to say about many important issues, such as the private and public provision of social security, the effects of the stock market on the economy, the effects of demographic change on national saving, the role of saving in economic growth, and the determinants of national wealth.
Keywords: Modigliani, saving, consumption, life-cycle
JEL Classification: B31, D91, E21
Suggested Citation: Suggested Citation