Retirement and Economic Behavior

By Henry J. Aaron; Gary Burtless | Go to book overview

Sally R. Merrill


Home Equity and the Elderly

As the long-term financing problems of social security have become more serious, increasing attention has been directed to assessing alternative sources of retirement income. In particular, the decumulation of personal wealth could make a larger contribution to providing for consumption after retirement. In the economic literature total wealth is considered in the context of the life-cycle theory of savings. Less attention has been paid to the composition of the asset portfolio or to the behavior of home equity in the context of the life- cycle model.1

Housing is the major asset of most elderly households. Approximately 70 percent of elderly householders currently own their home, and a

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1
.The life-cycle theory of savings has received extensive theoretical development and empirical testing. See, for example, Franco Modigliani and Richard Brumberg, "Utility Analysis and the Consumption Function: An Interpretation of Cross-Section Data," in Kenneth K. Kurihara, ed., Post Keynesian Economics ( Rutgers University Press, 1954), pp. 388-436; Milton Friedman, A Theory of the Consumption Function ( Princeton University Press, 1957); Menahem E. Yaari, "Uncertain Lifetime, Life Insurance, and the Theory of the Consumer," Review of Economic Studies, vol. 32 ( April 1965), pp. 137-49; Martin Feldstein, "Social Security, Induced Retirement, and Aggregate Capital Accumulation," Journal of Political Economy, vol. 82 ( September- October 1974), pp. 905-25; Feldstein, "The Effect of Social Security on Saving," National Bureau of Economic Research Working Paper 334 ( Cambridge, Mass.: NBER, April 1979); Feldstein, "Social Security Benefits and the Accumulation of Preretirement Wealth," NBER Working Paper 477 ( NBER, May 1980); Martin Feldstein and Anthony Pellechio , "The Determinants of Exchange Rate Flexibility: An Empirical Investigation," Review of Economics and Statistics, vol. 61 ( August 1979), pp. 361-67; and Peter Diamond and Jerry A. Hausman, "Individual Savings Behavior," a paper prepared for the National Commission on Social Security, May 1980. In its simplest form, the theory assumes a hump-shaped curve for total wealth across the life cycle with the maximum being reached at the point of retirement. The primary motivation for accumulating wealth is synchronization of consumption and income during the life cycle of work and retirement periods. The theory can also accommodate other savings motives, such as bequests, and other humps in the curve, such as financing of children's education.

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