The precautionary motive to delay consumption and save in the current period rises due to the lack of completeness of insurance markets.
[attribution needed] Defining this concept, individuals save out of their current income to smooth the expected consumption stream over time.
The relevance of the life-cycle framework, therefore, builds on intertemporal allocation of resources between the present and an uncertain future with the goal of maximizing utility.
Rational individuals take sequential decisions to achieve a coherent and ‘stable’ future goal using currently available information.
[9] More extensive research has confirmed the presence of a precautionary motive for saving within the permanent income hypothesis framework.
This is met with an opposite force, as higher riskiness makes it necessary to save more in order to protect oneself against very low levels of future consumption.
Insurance market incompleteness was introduced by assuming a large number of individuals who receive idiosyncratic labor income shocks that are uninsured.
[17] In other words, the heterogeneity of consumption/saving behavior of individuals in the economy makes it difficult to precisely quantify the precautionary motive for saving.
Industrial workers at the time significantly reduced their saving and insurance consumption by approximately 25 percent when their expected post accident benefits increased.
[18] Subsequent analysis from Kazarosian (1997), using data from the National Longitudinal Survey, has shown that a doubling of uncertainty increases the ratio of wealth to permanent income by 29%.
Under this notion, uncertainty about households' anticipated future income, due to expected unemployment, strengthens the precautionary motive for saving and hence holds down consumption spending (cetrus paribus).
[22] In the context of business cycles, Challe and Ragot (2010) showed that shocks to labor productivity affect firms' incentives to create jobs and hence the expected duration of unemployment spells.
Saving rates of fast-growing emerging economies have been rising over time, leading to surprising “upstream” flows of capital from developing to rich countries.
The model was able to confirm the precautionary motive of sovereigns' accumulated assets (as a ratio to GDP) in response to risks of global imbalances.