Lesson 5 — Ageing, Consumption & Savings

Life-Cycle Model: core idea

Individuals are forward-looking and smooth consumption over their lifetime, equalising marginal utility.

Why is consumption flat over life?

Because individuals aim for consumption smoothing despite rising and falling income.

Income path over life

Income rises during working years, peaks in midlife, then falls near retirement.

Savings behaviour by age

Young borrow, working-age save, elderly dissave by drawing down wealth.

Macro impact of ageing on savings

Ageing → more dissavers → lower aggregate savings → weaker investment and slower growth.

LCM prediction: rising income

More income increases both consumption and savings.

LCM prediction: higher income growth

Higher permanent income means both consumption and savings rise.

LCM prediction: raising retirement age

Extends working years → increases lifetime resources → raises both consumption and savings.

LCM prediction: increasing life expectancy

Longer life requires stretching consumption; savings rise during working years to prepare for retirement.

LCM prediction: falling fertility (short run)

Fewer dependents → households save more → national savings rise.

LCM prediction: falling fertility (long run)

Large older cohorts eventually retire → dissaving rises → national savings fall.

Ageing & consumption structure

Young spend on goods; elderly spend on healthcare/services → shift toward lower productivity sectors.

Effect of ageing on productivity structure

Shift to low-productivity services may reduce GDP growth unless offset by innovation.

Aggregate savings: ageing effect

Ageing increases aggregate consumption and reduces aggregate savings.

Why retirees reduce national savings

Elderly are dissavers; as their share grows, national savings decline.

Policy concern: retirement adequacy

Governments face pressure if individuals under-save for retirement.

Horioka (2010): salaried elderly behaviour

Salaried elderly still save positively, though less than in the past.

Horioka (2010): retired elderly behaviour

Retired elderly strongly dissave; dissaving has grown over time.

Horioka (2010): main conclusion

Not all elderly dissave; effect concentrated among retirees; Japan still faces ageing pressures.

Wong & Tang (2013): purpose

To test whether ageing reduces savings once longevity effects are included.

Direct ageing effect

Higher old-age dependency increases dissaving, reducing national savings.

Indirect longevity effect

Longer life expectancy increases precautionary savings for longer retirements.

Regression findings: life expectancy

Life expectancy has a positive and significant impact on savings.

Regression findings: old-age dependency

Old-age dependency is not significant when LE is included; becomes negative only when LE omitted.

Key implication: ageing & savings

Ageing does not necessarily reduce savings—longevity-driven savings can offset dissaving.

Policy relevance

Institutions, pension systems, and policy design heavily influence national saving rates.

Does the basic LCM always hold?

Not necessarily; ageing does not always reduce savings or increase consumption according to extended models and GE effects.

Cross-country evidence on LCM

US and Taiwan follow LCM; UK and Thailand do not, showing divergent age-savings profiles.

Why age alone is insufficient for savings patterns

Behavioural, institutional, and macroeconomic factors interfere with simple age-based predictions.

LCM extension: uncertainty

Longer life expectancy increases retirement saving; uncertainty raises savings.

LCM extension: precautionary savings

Negative expectations about future income or health increase precautionary savings.

LCM extension: insurance & savings

Weak insurance systems strengthen precautionary saving responses.

LCM extension: bequest motives

Strong bequest motives increase elderly savings and reduce dissaving.

Bequest motive ambiguity

Bequests increase savings for givers but reduce savings for recipients, making effects ambiguous.

LCM extension: pension systems

PAYG vs self-funded systems alter voluntary savings behaviour.

Why pension design affects savings

Pension incentives can increase or decrease private saving depending on structure.

LCM extension: Retirement consumption puzzle

Consumption patterns in retirement vary across countries—falls, rises, or remains unchanged.

Reasons consumption may fall in retirement

Home production and reduced work-related expenses reduce retirement consumption.

Reasons consumption may rise in retirement

Increased leisure spending or cultural norms can raise retirement consumption.

LCM extension: General equilibrium: aggregate savings

Falling household savings does not imply falling aggregate savings in GE framework.

General equilibrium: interest rate adjustment

Falling household savings can raise interest rates, which feeds back into investment demand.

General equilibrium: corporate & public savings

Corporate and government savings may offset declining household savings.