The Life Cycle Hypothesis

by: Claus Vistesen

Depending on the wording, a search on Google Scholar for papers and research on the link between macroeconomics and demographics yields anywhere between 20,000 and 100,000 results. This is an unhelpful start for someone looking to explore and understand the field. This essay aims to rectify this issue by tracing the origins of the life cycle hypothesis (LCH) - ground zero for linking macroeconomics and demographics - through a close inspection of the 1950s literature that gave birth to the theory. It is motivated by the idea that anyone who wishes to explore this topic needs to have a firm grasp of the original material. A lot can be said for getting the basics right, and this essay is an ode to that idea.

This essay introduces something new here at Alpha Sources, so if you want to get a bit of background of what I am trying to do, I have tried to explain it below.

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As a financial market and economics geek, I am lucky to be part of a diverse group of investors, analysts and generally interesting people. We meet a couple of times a year - though we exchange ideas daily - and the last time we convened, I was put on the spot. Walking through Regent Park on a misty Saturday afternoon, one of the fund managers in the group pinned me down to provide examples of interesting texts that explain and treat economics in a non-technical, non-academic and engaging way. His point of departure was a glowing review of a book on physics that he had recently read, I can’t remember the title, which offered a sweeping overview of that particular subject matter in that way. When it came time for me to list a number of books on economics with similar characteristics, I came up woefully short.

Two qualifiers are immediately necessary. First, the fact that I couldn’t answer his question is as much to do with my lack of readership as it is to do with the fact that these texts don’t exist. I think the problem is that the myriad of texts which I could conceivably have offered as examples, if only to name-drop, are as much about business, finance - even history - as they are about economics. Second, there are plenty of good economics textbooks, but many of them emphasise mathematical derivation and rigour over intuition. This, at least, is my personal experience. Many non-technical economics textbooks are well-written, but they tend to follow a pre-set journey through economic theory - usually from Keynes to neoclassical theories on to New Keynesianism - which isn’t necessarily a useful prism through which to understand (macro)economics. I suppose the field of economics is now in the process of changing that story, hopefully for the better, but a key quandary remains. Economics presents itself to the world as a field which is often far removed from the reality that investors, business owners and policymakers act in and identify as having to do with the economy and economic processes.

My friend’s unanswered question immediately posed another, which has been rattling in my head for a while. How would I write such a book? Frankly, I have no idea. I doubt that a single text can distill the field of economics in the same way as you can with a hard science such as physics or mathematics. This is because you either stick to the strict conventions of what is generally understood as economics and end up doing something that has already been done. Or, you broaden the scope too wide and find yourself writing a treatise on social sciences as a whole - an ambitious and admirable task, but not something that I have time for.

The best that I can do is to divide this challenge into small, even tiny, parts. Like any body of knowledge, economics can, at least tentatively, be broken down into a number of self-contained ideas and theories that have evolved over time. If I can take a few of those - especially the ones that I know best - and present them to my readers in a new, and hopefully more informative, light, I reckon it constitutes a first small step towards answering my friend’s question.

I hope to be able to do one a quarter, but no promises. I hope you enjoy it.