Comparative Efficacy of Life-Cycle and Absolute Income Hypothesis in Pakistan

Abstract

In Pakistan more than 90% of national saving comprises of household saving but this household saving hovering around 12% to 14%, of the GDP. This study is one of the early attempts in Pakistan to examine the household lifecycle saving behavior using the methodology of Modigliani and Shi (2004). Unlike previous studies in Pakistan this study uses GDP growth rather than GDP level to test lifecycle hypothesis. Similarly in demographic variables the dependency ratio is taken as percentage of employed labor force rather than the total labor force. Present study based on time-series data from 1973 to 2015, taken from the State Bank of Pakistan Annual Reports, 50 Years of Pakistan Economy, and various issues of the Economic Survey of Pakistan. In order to estimate the saving determinates the Bounds testing approach is applied to ensure the Co-integration and the long-run coefficients are estimated through OLS. The estimated results of long-rum regression show that the dependency ratio (less than 14 years population) has significant negative effect on average saving and the growth differential variable has also insignificant negative effect showing that any transitory shock on income has no significant effect on average saving. Similarly, the long-term growth has insignificant effect on saving which does not support the hypothesis of virtuous circle that goes from faster growth to increased saving to even higher growth. The coefficient of inflation is significant with expected negative sign. Finally, the Keynesian variable estimated by per capita income is significant with expected positive sign, which indicates that a rise in per-capita income will increase the saving. The overall results do not support the lifecycle hypothesis in case of Pakistan but reinforce the existence of absolute-income hypothesis. These results emphasized some important policy implication for monetary policy as inflation was found to have negative impact on household savings, ensuring price stability and low inflation will be conducive to augment household savings and thus sustain higher economic growth. The results also emphasize that in order to increase the saving both inflation and any transitory shock that effect negatively on saving needs to be controlled.