The Importance of Precautionary Motives in Explaining Individual and Aggregate Saving

Abstract

This paper examines predictions of a life-cycle simulation model -- in which individuals face uncertainty regarding their length of life, earnings, and out-of-pocket medical expenditures, and imperfect insurance and lending markets -- for individual and aggregate wealth accumulation. Relative to life-cycle or buffer-stock alternatives, our augmented life-cycle model better matches a variety of features of U.S. data, including: (1) aggregate wealth, (2) cross-sectional differences in wealth-age and consumption-age profiles by education group, and (3) short-run time-series co-movements of consumption and income.