What is the Life-Cycle Hypothesis (LCH)

The Life-Cycle Hypothesis (LCH) is an economic theory that pertains to the spending and saving habits of people over the course of a lifetime. The concept was developed by Franco Modigliani and his student Richard Brumberg. LCH presumes that individuals plan their spending over their lifetimes, taking into account their future income. Accordingly, they take on debt when they are young, assuming future income will enable them to pay the debt off. They then save during middle age in order to maintain their level of consumption when they retire. This results in a "hump-shaped" pattern in which wealth accumulation is low during youth and old age, and high during middle age.

BREAKING DOWN Life-Cycle Hypothesis (LCH)

The Life Cycle Hypothesis replaced an earlier hypothesis developed by economist John Maynard Keynes. He believed that savings were just another good and that the percentage that individuals allocated to savings would grow as their incomes rose. This presented a potential problem in that it implied that as a nation's incomes grew, a savings glut would result, and aggregate demand and economic output would stagnate. Subsequent research has generally supported the Life Cycle Hypothesis.