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 in the early 1950s.
- The life-cycle hypothesis (LCH) is an economic theory developed in the early 1950s.
- It posits that people plan their spending over the course of their lifetimes, factoring in their future income.
- It results in a “hump-shaped” pattern of wealth accumulation that is low during youth and old age and high in middle age.
The 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 it 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.
The life-cycle hypothesis (LCH) has largely supplanted Keynesian economic thinking about spending and savings patterns.
Life-Cycle Hypothesis vs. Keynesian Theory
The LCH replaced an earlier hypothesis developed by economist John Maynard Keynes in 1937. He believed that savings were just another good and that the percentage individuals allocated to their 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.