BUFFER-STOCK SAVING AND THE LIFE CYCLE PERMANENT INCOME HYPOTHESIS/

This paper argues that the typical household's saving is better descri bed by a ''buffer-stock'' version than by the traditional version of t he Life Cycle/Permanent Income Hypothesis (LC/PIH) model. Buffer-stock behavior emerges if consumers with important income uncertainty are s ufficiently impatient. In the traditional model, consumption growth is determined solely by tastes. In contrast, buffer-stock consumers set average consumption growth equal to average labor income growth, regar dless of tastes. The model can explain three empirical puzzles: the '' consumption/income parallel'' documented by Carroll and Summers; the ' 'consumption/income divergence'' first documented in the 1930s; and th e stability of the household age/wealth profile over time despite the unpredictability of idiosyncratic wealth changes.