Why Does Consumption Fluctuate in Old Age and How Should the Government Insure It?
In old age, consumption can fluctuate because of shocks to available resources and because health shocks affect utility from consumption. We find that even temporary drops in income and health are associated with drops in consumption and most of the effect of temporary drops in health on consumption stems from the reduction in the marginal utility from consumption that they generate. More precisely, after a health shock, richer households adjust their consumption of luxury goods because their utility of consuming them changes. Poorer households, instead, adjust both their necessary and luxury consumption because of changing resources and utility from consumption.
Richard Blundell gratefully acknowledges financial support from the ESRC Centre for the Microeconomic Analysis of Public Policy at the IFS (ES00116). We are grateful to Marco Bassetto for helpful comments and suggestions. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research, the CEPR, the Federal Reserve Bank of Minneapolis, or the Federal Reserve System.