Answer to Question #17300 in Macroeconomics for Rajib Sinha
What are the implications of the life cycle hypothesis for the effectiveness of
The LCH affects our understanding of the working of the economy and of the effectiveness of fiscal and monetary policies. For instance, LCH provides a direct link between monetary policy, interest rate and consumption, because a change in the interest rate affects the market value of assets and therefore consumption. As for fiscal policy, LCH suggests that expenditures financed by deficit tend to be paid by future generations; those financed by taxes are paid by current generations (Modigliani, 1961). National debt is therefore a burden: it reduces the stock of private capital, which in turn reduces the flow of output, if capital is productive. Indeed, Modigliani (1966) provided the first test of this proposition using aggregate US wealth data.