Economic Analysis Series No.174
Consumption and Saving Behavior of the Japanese in 1990's
-Theoretical Results and Empirical Studies of Precautionary Saving Motive-

June, 2004
Hidehiko Ishihara
(Senshu University, Former Visiting Fellow, Economic and Social Research Institute, Cabinet Office)
Takero Doi
(Keio University, Visiting Fellow, Economic and Social Research Institute, Cabinet Office)

The full text is written in Japanese.



In this paper, I survey the theories how income fluctuation affects the process of consumption, especially on the life-cycle/ permanent income hypothesis and the precautionary motive of saving. I also give some remarks on empirical studies of consumption.

First I reexamine the implication of the life-cycle/ permanent income hypothesis. This theory has a concrete microfoundation, but there was no valid econometric method for verifying, until the well-known "Random-Walk Hypothesis" of Hall (1978). Hall's hypothesis was rejected statistically in two aspects, however. The one is that the current and/or past levels of income help the prediction of the future consumption. This is called "excess sensitivity" of consumption. The other is that the variance of consumption is strictly smaller than that of the permanent income. This is called "excess smoothness" of consumption. Some studies tried to explain these two facts by extending the standard "certainty-equivalence" model in some aspect, such as preference shock, durables, habit formation, and aggregation of different agents. We reviewed some of these models with the assumption that the instantaneous utility function is quadratic, and we found that some extensions can explain both excess sensitivity and excess smoothness only if the stochastic process of income is nonstationary. In these cases, the response of consumption to unexpected income change is smaller than that of the certainty-equivalence model.

The rest of the paper, I survey the studies of precautionary savings. Roughly speaking, a household has a precautionary motive of saving if the third derivative of his instantaneous utility function, u'''(c), is positive. The work of Kimball (1990) on "prudence" gives the measure of the strength of the precautionary saving motive. Caballero (1990) studies the optimal consumption-saving decision of an infinitely living household with constant absolute risk aversion (CARA) utility. He shows that, in case of homoscedastic labor income, the stochastic process of consumption follows a martingale with drift, which is just like in the certainty-equivalence model. Next we review the "buffer stock" theory of saving, propounded by Carroll (1992, 1997). He shows that, if the absolute risk aversion is decreasing in consumption, a household regards its non-human wealth as a "buffer" for labor income fluctuation and chooses consumption so as to keep his non-human wealth to an appropriate level. A linear approximation of this "buffer stock" model explains both excess sensitivity and excess smoothness at the same time, even if the stochastic process of income is stationary.

Finally the advices on empirical studies of precautionary savings, which is derived from the theoretical studies above, are given. Many of the previous studies neglect to examine the behavior of the stochastic processes of independent variables, and suffer serious misspecifications of the lack of non-human wealth.

Increase in Saving Rate and Precautionary Saving Motive in Japan

This paper analyzes the reason that Japan's household saving rate rose in the 1990s. The unemployment rate as well as saving rate of workers' households was increasing in the 1990s, and growth rate of disposable income was decreasing in the late 1990s. The evidence may imply that an increase in the saving rate is explained by precautionary saving motive among growing uncertainty (risk) concerning future income and employment. An increase in income risk means that households' expectation of future income becomes more uncertain. This paper investigates this evidence, and finds that correlation between Japan's saving rate of workers' households (using data for the Family Income and Expenditure Survey) and the income risk is significantly positive during the full sample period (from 1976 to 1998), but not significantly positive in the recent years. Therefore it is concluded that the increase in Japan's household saving rate in the 1990s is not explained by precautionary saving hypothesis with the income risk.

To explain recent movements in the saving rate, this paper examines whether or not the hypothesis in any other means is supported. We find that correlation between the saving rate and the employment risk is significantly positive during the sample period (after 1986). The data on the mean of expected unemployment rate (or active job opening ratio) are newly constructed as employment risk. Thus it is concluded that the increase in household saving rate in the 1990s is explained by precautionary saving motive with the employment risk. This conclusion means that the saving rate increased because not workers' future income became more uncertain but households' possibility of unemployment strengthened.

This paper also investigates the aggregate nominal precautionary saving with employment risk for workers' households. The saving (in flow term) amounted to approximately 4 trough 7 trillion yen in the late 1990s. If the employment risk could be eliminated, the Japanese workers' households spent their precautionary saving for their consumption, and the then GDP would make a further rise of 0.2-0.25%.

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