Why do the Rich Save More? A Theory and Australian Evidence

Abstract

We provide a theory to explain the existence of inequality in an economy where agents have identical preferences and have access to the same production technology. Agents consume a “utility” good and a “health” good which determines their subjective discount factor. Depending on initial distribution of capital the economy gets separated into different permanent-income groups. This leads to a testable hypothesis: “The rich save a larger proportion of their permanent income”. We test this implication for the savings behaviour in Australia. We show that even after controlling for life-cycle characteristics permanent income and savings are positively correlated. An improvement in the health leads to a positive effect on savings behaviour.