Association for Public Policy Analysis & Management

Though a rich branch of literature examined the relationship between housing wealth and household consumption, very few of them touched upon how the aging demographic changes will reshape both per household and aggregate level housing wealth effect on consumption decision. This study, by investigating the marginal propensity to consume (MPC) for the elderly population with respect to housing wealth shocks and identifying the heterogeneity sources in differential consumption responses, uncovers how elder households respond to both permanent and transitory large housing wealth shocks during the most recent housing boom and bust cycle.

The United States is experiencing a process of rapid aging of the population of which 20 percent will be over the age of 65 by 2029. By using the HRS data which provides detailed information on elder households’ income, housing wealth, consumption and savings, health status and insurance, retirement plans, and intergenerational transfers, this study examines the MPCs with respect to housing net worth across several aging cohorts –Children of the Depression, War Baby, Early Baby Boomers and Middle Baby Boomers– and explores the differential impact across various consumption categories. The preliminary empirical results reject the consumption risk-sharing hypothesis and strongly support the heterogeneity in the MPCs. Sources for the heterogeneity examined in this paper include the bequest motive, cohort effect, uncertainty in lifespan, current health status, engagement in long-term care insurance and financial support from their children. Preliminary empirical results highlight the role of cohort effect and bequest motive in explaining precautionary savings. This paper highlights the role of home equity with intergenerational hedging incentive in shaping the consumption behaviors under the current demographical aging trend.

To cope with the endogeneity issue in housing wealth associated with potential unobserved income shocks, this study employs three methods. First, utilizing the HRS data on respondent-kid, I use net home equity directly by controlling for the financial transfer from kid to respondent –the most likely income shocks for the retirees occurred in the error term given the stable pension income after retirement. Second, by merging the zip-code level geographical data, I instrument the net housing wealth change by utilizing the MSA-based housing supply inelasticity and changes in zip-code level housing prices indexes. Third, I instrument the net housing wealth change with the lagged property tax and interact it with a dummy of property tax rate cap.

This research will lay empirical foundations for future research comparing MPCs between younger and older households and further assessing whether a zero-sum redistribution of wealth (from older to younger households) within the U.S. population can have persistent aggregate effects associated with macro-level monetary policies. Moreover, understanding the consumption behaviors of the elderly will provide policy insights on designing better financial instruments based on their home equity to finance their life after retirement.