Consumption and Saving: Another Glance at the Life Cycle Framework

Abstract

This paper investigates the behavior of consumption and saving in Malaysia from the perspective of the life cycle hypothesis (LCH). Specifically, the analysis employs the Deaton-Paxson model which decomposes the pattern of household consumption and saving into age effects and cohort effects. Using the household data from three Household Expenditure Surveys of Malaysia, this study produces two key results. First, the age effects of income and consumption rise with age but the latter rise more rapidly; thus, the age effects of saving fallwith age. This set of results suggests that individuals engage in a lifetime saving plan early in their working lives (which is consistent with the prediction of LCH); yet, their saving falls gradually over time and approaches zero (instead of becoming negative) toward the end of their lifetime (inconsistent with the prediction of LCH). Second, the cohort effects of income and consumption fall with cohort but the latter fall more rapidly; hence, the cohort effects of saving rise with cohort. This set of results suggests that economic boom generates an unwarranted optimism in that individuals choose to consume at the expense saving; therefore, growth stimulates consumption instead of saving (inconsistent with the prediction of LCH).