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and actual behaviour is that people drastically 'underconsume' early and late in their lifetime by failing to borrow against future earnings and not saving enough to adequately finance retirement incomes respectively. People also seem to 'overconsume' during their highest earning years, the elderly do not consume from their assets as would be expected (particularly from their household equity) and also treat windfall gains in a manner inconsistent with the life-cycle model. Specific alterations to the theory have been proposed to help it accommodate the data; a
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Attempts to test the life-cycle model against real world data have met with mixed success. In a review of the literature, Courant, Gramlich and
Laitner (1984) note "but for all its elegance and rationality, the life-cycle model has not tested out very well". The main discrepancies between predicted
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instead of income at any given age. First, young people borrow to consume more than their income, next, as their income rises through the years, their consumption rises slowly and they begin to save more. Lastly, during their retirement these individuals live off of their savings. Furthermore this
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and windfall gains they hypothesize that the MPC is close to one out of current income, close to zero for future income and somewhere in between with respect to current assets. These differing MPCs explain why people 'overconsume' during their highest earning years, why increasing superannuation
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contributions does not cause current savings to be reduced (as the life-cycle model implies) and why small windfall gains (which are coded as current income) are consumed at a high rate but a higher proportion of larger gains is saved.
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theory and approached the question of inter-temporal consumption as a lifetime income optimization problem. Solving this problem mathematically, assuming that individuals are rational and have access to complete markets,
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theory implies that consumption is smoothed out relative to a person's income which is the reason economists set consumption proportional to potential income rather than actual income.
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Modigliani, F. & Brumberg, R. (1954): 'Utility analysis and the consumption function: An interpretation of cross-section data'. In: Kurihara, K.K (ed.):
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Shefrin, H. & Thaler, R. (1992): 'Mental
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Intertemporal choice § Modigliani's life cycle income hypothesis
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