How Large is the Retirement Consumption Drop in Italy?

How large is the retirement Consumption Drop in Italy? Erich battistin Agar brugiavini Enrico rettore Guglielmo Weber

How Large is the Retirement Consumption Drop in Italy? Erich Battistin Agar Brugiavini Enrico Rettore Guglielmo Weber

Motivation wadb According to the life-cycle permanent income Hi consumers decide how much to consume, keeping in mind their future prospects They form intertemporal plans aimed at smoothing the (discounted )marginal utility of consumption over the life cycle Any period to period change in the actual level of the marginal utility of consumption is uncorrelated with past information available to the household. That is ,it should be a result of unpredictable shocks

Motivation • According to the life-cycle permanent income Hp consumers decide how much to consume, keeping in mind their future prospects • They form intertemporal plans aimed at smoothing the (discounted) marginal utility of consumption over the life cycle • Any period to period change in the actual level of the marginal utility of consumption is uncorrelated with past information available to the household. That is, it should be a result of unpredictable shocks

Motivation wadb This holds true also around retirement age: any change in the marginal utility of consumption should be uncorrelated with planned retirement behaviour Recent micro evidence has emphasized that there is a one-off drop in consumption at the time of retirement that might be hard to reconcile with life-time optimizing behaviour(see for example Banks et al 1998. Bernheim et al. 2001 This is known as the retirement consumption puzzle

Motivation • This holds true also around retirement age: any change in the marginal utility of consumption should be uncorrelated with planned retirement behaviour. • Recent micro evidence has emphasized that there is a one-off drop in consumption at the time of retirement that might be hard to reconcile with life-time optimizing behaviour (see for example Banks et al., 1998, Bernheim et al., 2001). • This is known as the retirement consumption puzzle

Motivation wadb Some possible reasons mentioned in the literature changes in preferences due to increased lei Isure shocks inducing retirement and affecting the level of consumption reduction in work-related expenditures(transport meals out, clothing increase in home production of services and/or more efficient purchases unexpectedly low pensions or liquidity problems(not in italy though -think of severance pay uidazione

Motivation Some possible reasons mentioned in the literature: • changes in preferences due to increased leisure • shocks inducing retirement and affecting the level of consumption • reduction in work-related expenditures (transport, meals out, clothing) • increase in home production of services and/or more efficient purchases • unexpectedly low pensions or liquidity problems (not in Italy, though – think of severance pay - liquidazione!)

What others have done Banks, Blundell and Tanner(1998)use repeated cross section data from the fes -they estimate log- linear Euler equations from cohort data by iv(using lagged interest rates, consumption and income growth as instruments) and find unexplained negative residuals around typical male retirement ages(60-67) he largest residual obtains at age 63(1.5% Altogether, cumulated residual are in the 8-10% region Non-separabilities between leisure and consumption can explain only part of the drop

What Others Have Done • Banks, Blundell and Tanner (1998) use repeated cross section data from the FES – they estimate log￾linear Euler equations from cohort data by IV (using lagged interest rates, consumption and income growth as instruments) and find unexplained negative residuals around typical male retirement ages (60-67). • The largest residual obtains at age 63 (1.5%). Altogether, cumulated residual are in the 8-10% region. • Non-separabilities between leisure and consumption can explain only part of the drop

What others have done Bernheim, Skinner and Weinberg(2001)use panel data from the psid to estimate euler equations Retirement status is instrumented by taking age specific predicted probabilities conditional on demographics(however cannot explain spikes at ages 62 and 65) Median drop is 14%, but higher for low wealth Sample is split in groups: low wealth-to-income households drop their consumption most 31%of households reduce their consumption by at least 35 percentage points at retirement

• Bernheim, Skinner and Weinberg (2001) use panel data from the PSID to estimate Euler equations. Retirement status is instrumented by taking age￾specific predicted probabilities conditional on demographics (however cannot explain spikes at ages 62 and 65). • Median drop is 14%, but higher for low wealth • Sample is split in groups: low wealth-to-income households drop their consumption most. • “31% of households reduce their consumption by at least 35 percentage points at retirement”. What Others Have Done

What others have done Possible explanations and related literature Many workers are surprised by inadequate resources when they retire(not consistent with life-cycle model rational expectations) Work related expenses Home production and/or more efficient shopping (Aguiar and hurst, 2005, Hurd and rohwedder 2006) Miniaci et al(2003)estimate by ols the italian retirement consumption drop at 5.4%

Possible explanations and related literature: • Many workers are surprised by inadequate resources when they retire (not consistent with life-cycle model & rational expectations). • Work related expenses. • Home production and/or more efficient shopping (Aguiar and Hurst, 2005, Hurd and Rohwedder, 2006). • Miniaci et al (2003) estimate by OLS the Italian retirement consumption drop at 5.4%. What Others Have Done

What We do An alternative identification strategy: we estimate the change in consumption at retirement by exploiting the exogenous variability in the retirement decision induced by the eligibility rules of the Italian pension system Information on consumption expenditures, eligibility for retirement and retirement status is obtained from the bank of Italy survey on household Income and Wealth(SHIW). No need of panel data to achieve identification

What We Do • An alternative identification strategy: we estimate the change in consumption at retirement by exploiting the exogenous variability in the retirement decision induced by the eligibility rules of the Italian pension system. • Information on consumption expenditures, eligibility for retirement and retirement status is obtained from the Bank of Italy Survey on Household Income and Wealth (SHIW). No need of panel data to achieve identification

Punchline Key result: household non-durable consumption drops by 9.8% because of male retirement. A larger drop estimated for total food(14.1%) Our strategy provides non-parametric identification only for a subpopulation of those who retire(those who retire at the time they become eligible) We estimate smaller drops for poverty sample Our estimates can be reconciled with utility optimization-in the cross section, drop in work- related expenses and leisure substitutes is large enough to explain changes in consumption

Punch-line • Key result: household non-durable consumption drops by 9.8% because of male retirement. A larger drop estimated for total food (14.1%). • Our strategy provides non-parametric identification only for a subpopulation of those who retire (those who retire at the time they become eligible). • We estimate smaller drops for “poverty sample”. • Our estimates can be reconciled with utility optimization - in the cross section, drop in work￾related expenses and leisure substitutes is large enough to explain changes in consumption

The Causal problem Let s be a variable denoting time to from eligibility for retirement, negative values indicate that the subject is not yet eligible Let r be the retirement status r=l for the retired and r=o otherwise. Since retirement is an option available only to the eligible workers, the probability to retire is zero if S<0(and it is thus discontinuous at S=0) et(Y,Yo be the two potential household consumption expenditures corresponding to the head being retired or not retired, respectively, and let B=YI-Yo et Y=Yo+rB be observed consumption, where Y=Y, for households whose head is retired and y=Yo otherwise

The Causal Problem • Let S * be a variable denoting time to/from eligibility for retirement, negative values indicate that the subject is not yet eligible. • Let R be the retirement status, R=1 for the retired and R=0 otherwise. Since retirement is an option available only to the eligible workers, the probability to retire is zero if S*<0 (and it is thus discontinuous at S*=0 ). • Let (Y1 ,Y0 ) be the two potential household consumption expenditures corresponding to the head being retired or not retired, respectively, and let β=Y1 -Y0 . • Let Y = Y0+Rβ be observed consumption, where Y≡Y1 for households whose head is retired and Y≡Y0 otherwise