The Interaction between Consumption and Health in Retirement

Abstract

We study the interaction between consumption and health in retirement. Our main contribution is the estimation of a consumption Euler equation taking health into consideration. The Euler equation is derived from a model of consumption in retirement with three important building blocks of health: health shocks, health as an investment and health as a provider of utility. We estimate the Euler equation using data from the Health and Retirement Study (HRS) and Consumption and Activities Mail Survey (CAMS). The estimates suggest that health is an important determinant of utility. We use the estimated model to study the empirical significance of the three building blocks of health. We find that health shocks play an important role in slowing down the decline of consumption with age in retirement. We also find that including health into the utility function could help explain the heterogeneous consumption-age profiles related to health. Finally, we find that health investments, such as physical exercise, have a significant effect on the evolutions of both health and consumption in retirement.