The Impact of Age Distribution Variables on the Long Run Consumption Function

Abstract

Modigliani's Life Cycle Hypothesis (LCH) predicts that demographic variables should play a significant role in our understanding of the relationship between consumption and income. Understanding this relationship is particularly important given the demographic changes expected in the next few decades. Unfortunately, evidence for the importance of demographic variables is mixed: unsurprisingly since such variables change relatively slowly and most analysis is confined to post war data. In this paper we use a much longer time series of aggregate variables (1856-1996) which models consumption, income and demographic effects in a vector error correction framework allowing for structural breaks. Our analysis shows that demographic effects have an important effect in the manner predicted by the LCH.

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