The Nature of Precautionary Wealth

This paper uses the Panel Study of Income Dynamics to provide some of the first direct evidence that wealth is systematically higher for consumers with predictably greater income uncertainty. However, the apparent pattern of precautionary wealth is not consistent with a standard parameterization of the life cycle model in which consumers are patient enough to begin saving for retirement early in life: wealth is estimated to be far less sensitive to uncertainty than implied by that model. Instead, our results suggest that over most of their working lifetime, consumers behave in accordance with the "buffer-stock" models of saving described in Carroll (1992, 1997) or Deaton (1991), in which consumers hold wealth principally to insulate consumption against near-term fluctuations in income. JEL Classification: D91, E21