Question

In May 2010, the size of the Greece’s budget deficit increased its probability of default and triggered a crisis across the Eurozone. To decrease the budget deficit, the Greek government proposed many measures. A few of them involved decreasing pension and/or benefits payments to retiree. Use the life-Cycle hypothesis to evaluate the impact of an unexpected decrease in the income of the retirees in Greece.

Answer 1

According to the Life Cycle Hypothesis , consumption is a function of life time expected income of the consumer. The aim of the consumer is to maximise his utility over his life time. This in turn depends upon the total resources available to him during his life time. In his early years, the consumer will be spending money without earning income. During his middle life, it is assumed that he will be earning more than he spends. In this stage he saves for the future. And in the final stage of his life cycle the consumer will spend a good deal and earn little or nothing. It is assumed that the consumption level of the consumer is somewhat constant or slightly increasing.

In this scenario, when the pension is decreased or benefit payments are reduced there will be a decrease in the income level post retirement. This will in turn affect the consumption. They will have to reduce the present consumption in order to cope with the decreased income. Now if consumption cannot be reduced all of a sudden they will again have to depend on some one else in order to meet their needs. Thus ,the persons dissavings increases .