By John Karl Scholz and Ananth Seshadri
In this project we extend an augmented lifecycle model, incorporating a Grossman-style model of health capital, to enhance understanding of factors influencing consumption, wealth and health. We develop three primary results when using the model to explore the effects of stylized versions of Medicare and Social Security on wealth and longevity. First, our model calibration implies consumption and health are complements. As health depreciates with age, households will get less utility from consumption than would be in the case of a lifecycle model that does not endogenize health. Second, it appears that forward-looking households, when confronted by a substantially reduced safety net, will respond by reducing consumption and by reducing their health investment and therefore longevity. Third, there is a potentially important difference between short- and long-run responses to policy.
I selected this paper this week because of this very interesting result that in the absence of a safety net, people invest less in health. This seems like a vicious cycle: with more fragile health they would need even more a safety net, but its absence worsens the situation even more. This result also runs counter to the intuition we have about idiosyncratic income shocks: the less one is insured, the more one does something about it.