What is the life cycle assumption (LCH)?
The life cycle assumption (LCH) is an economic theory that relates to the spending and saving habits of people over the course of a lifetime. The concept was developed by Franco Modigliani and his pupil Richard Brumberg in the early 1950s.
Key points to remember
- The life cycle hypothesis (LCH) is an economic theory developed in the early 1950s.
- It assumes that people plan their expenses over their lifetime, taking into account their future income.
- The result is a “bump-like” pattern of wealth accumulation that is low in youth and old age and high in middle age.
The LCH assumes that individuals plan their expenses during their lifetime, taking into account their future income. As a result, they go into debt when they are young, assuming that their future income will allow them to repay them. They then save in middle age to maintain their consumption level in retirement. The result is a “bump-like” pattern in which the accumulation of wealth is low during youth and old age and high during the fifties.
The life cycle hypothesis (LCH) has largely supplanted Keynesian economic thinking on spending and saving methods.
Life cycle hypothesis vs Keynesian theory
The LCH replaced an earlier hypothesis developed by economist John Maynard Keynes in 1937. He believed that saving was just another good and that the percentage of people allocated to their savings would increase as their incomes increased . This posed a potential problem insofar as it implied that as a nation’s incomes increased, a glut of savings would result and aggregate demand and economic output would stagnate. Subsequent research has generally supported the life cycle hypothesis.