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Saturday, June 09, 2012

Why Do the Wealthy Save So Much?

Larry Willmore:

Why do the wealthy save so much?, by Larry Willmore: ...The standard theory of saving behavior, known as the ‘Life Cycle’ hypothesis,... does the model explain why Bill Gates and Warren Buffet are giving away almost all their wealth before they die, just as steel tycoon Andrew Carnegie (1835-1919) did a century ago.

The Life Cycle model assumes that the only purpose of saving ... is to finance future consumption. Johns Hopkins economist Christopher D. Carroll in 1997 showed how and why “the model greatly underpredicts the amount of wealth held by the households at the top of the wealth distribution”. His essay is as relevant today as it was 15 years ago.

Here is a key paragraph from the conclusion:

A variety of evidence, both qualitative and quantitative, strongly suggests that people at the top end of the wealth and income distributions behave in ways that are substantially different from the behavior of most of the rest of the population. In particular, it is difficult to explain the behavior of these consumers using the standard Life Cycle model of consumption. A leading alternative to (or perhaps just an extension of) the Life Cycle model is the Dynastic model in which the decision maker cares about the utility of his descendants. The Dynastic model, however, has problems of its own, starting with the testimony of many wealthy households who say that providing an inheritance is not a principal motivation for saving and ending with the fact that childless wealthy old people do not appear to dissave. I argue that the simplest model capable of fitting all the facts is a [`Capitalist Spirit'] model in which wealth either enters the utility function directly as a luxury good, or wealth yields a stream of services that enter the utility function in ways that would be formally virtually indistinguishable from a model in which wealth enters the utility function directly.

Christopher D. Carroll, “Why Do the Rich Save So Much?“, The Johns Hopkins University, July 1997. ...

    Posted by on Saturday, June 9, 2012 at 09:37 AM in Economics, Saving | Permalink  Comments (35)


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