Precautionary Saving Over the Lifecycle

This paper studies the quantitative importance of precautionary wealth accumulation relative to life—cycle saving for retirement. Section 1 examines panel data on earnings from the PSID. Using a bivariate normal model of random effects, we find that second— period—of—life earnings are strongly positively correlated with initial earnings but have a higher variance. Section 2 studies the consequences for life—cycle saving. Households know their youthful earning power as they enter the labor market, but only in midlife do they learn their actual second—period earning ability. For plausible calibrations, precautionary saving only adds 5—6% to aggregative life—cycle wealth accumulation. Nevertheless, we find that, given borrowing constraints on households’ behavior, the variety of earning profiles that our bivariate normal model generates itself stimulates more than twice as much extra wealth accumulation as precautionary saving. Authors’ Acknowledgement The author gratefully acknowledges support from the U.S. Social Security Administration (SSA) through the Michigan Retirement Research Center (MRRC), project UM03—02. The opinions and conclusions of this research are solely those of the author and should not be construed as representing the opinions or policy of the SSA or any agency of the Federal Government or of the MRRC. Precautionary Saving over the Life Cycle