Michael G. Palumbo

Uncertain Medical Expenses and Precautionary Saving Near the End of the Life Cycle

This paper introduces a dynamic, structural model of household consumption decisions in which elderly families consider the effects of uncertain future medical expenses when deciding current levels of consumption. The model with uncertain medical expenses implies a potentially important role for precautionary saving incentives to explain slow rates of dissaving among elderly Americans during retirement. Rather than just simulating the stochastic dynamic model, preference parameters are estimated using panel data on health, wealth and expenditures for retired families. The health uncertainty model predicts consumption levels closer to observed expenditures than a life cycle model with uncertain longevity. However, elderly families typically dissave their financial assets more slowly than even the baseline health uncertainty model predicts is optimal.

The price of residential land in large US cities

Combining data from several sources, we build a database of home values, the cost of housing structures, and residential land values for 46 large US metropolitan areas from 1984 to 2004. Our analysis of these new data reveal that since the mid-1980s residential land values have appreciated over a much wider range of cities than is commonly believed. And, since 1998, almost all large US cities have seen significant increases in real residential land prices. Averaging across the cities in our sample, by year-end 2004, the value of residential land accounted for about 50 percent of the total market value of housing, up from 32 percent in 1984. An implication of our results is that housing is much more land intensive than it used to be, meaning that the future course of home prices--the average rate of appreciation and volatility--is likely to be determined even more by demand factors than was the case even ten or twenty years ago.

A primer on the economics and time series econometrics of wealth effects

This paper reviews the statistical approach typically applied by macroeconomists to investigate the empirical links among aggregate data on household consumption, income, and wealth. In particular, we focus on studies determining whether and how much changes in net worth, such as those generated by the stock-market boom in the U.S. over the latter 1990s, are responsible for subsequent swings in the growth rate of consumer spending. We show how simple economic theory is used to motivate an econometric strategy that consists of two stages of analysis. First, regressions are used to identify trend movements shared by consumption, income, and wealth over the long run, then deviations of these series from their commong long- run trends are used to help forecast consumption growth over the short run. Our discussion highlights the various judgments that researchers must make in the course of implementing this empirical approach, and we detail how specific parameter estimates describing the magnitude of the wealth effect on consumption--and even broad conclusions about its existence--are affected by making alternative choices.

Disentangling the Wealth Effect: A Cohort Analysis of Household Saving in the 1990s

In the U.S., household net worth rose substantially in the latter half of the 1990s and the personal saving rate dropped sharply. Researchers do not agree about just what behavior links these two events, or how to interpret the negative correlation between wealth and the saving rate over a longer time span. In this paper, we combine household-level data from the triennial Survey of Consumer Finances with quarterly, aggregate data from the Flow of Funds Accounts to estimate net worth and saving for different cohorts of households in the 1990s. We find that the groups of households whose balance sheets were boosted the most by surging equity prices were also the groups that substantially decreased their saving rates. Further, econometric analysis of these data produces propensities to consume out of wealth in the range of typical estimates obtained from aggregate data. Taken together, our results corroborate a direct view of the wealth effect on consumption.

On the Relationships between Real Consumption, Income, and Wealth

The existence of durable goods implies that the welfare flow from consumption cannot be directly associated with total consumption expenditures. As a result, tests of standard theories of consumption (such as the Permanent Income Hypothesis, or PIH) typically focus on nondurable goods and services. Specifically, these studies generally relate real consumption of nondurable goods and services to measures of real income and wealth, where the latter are deflated by a price index for total consumption expenditures. This paper demonstrates that this procedure is only valid under the assumption that real consumption of nondurables and services is a constant multiple of aggregate real consumption outlays - an assumption that represents a very poor description of U.S. data. The paper develops an alternative approach that is based on the observation that the ratio of these series has historically been stable in nominal terms, and uses this approach to examine two basic predictions of the PIH. We obtain significantly different results relative to the traditional approach.

Optimal intertemporal consumption decisions under the threat of starvation

Abstract This paper studies consumption and saving decisions over time in a life cycle model in which survival from one period to the next is endogenous. Survival probabilities depend on health, which is a capital stock subject to depreciation and which can be augmented by consumption (nutrition). Borrowing is ruled out in our model and we investigate optimal consumption decisions when income fluctuates at seasonal frequencies and when income follows a stochastic process. Among other results, we show that understanding the pattern of income is necessary for understanding consumption decisions when survival is probabilistic and endogenous.

Policy Interaction in the Provision of Unemployment Insurance and Low‐Income Assistance by State Governments

In this paper we investigate empirical relationships between Unemployment Insurance (UI) and welfare policies using a unique database covering 48 states annually from 1973 through 1989. We first document substantial variation across states in UI program outcomes. Having established that UI is so variable, we explore the simultaneous interaction between UI and Aid to Families with Dependent Children (AFDC), Medicaid, and total state and local welfare spending. Our econometric results indicate substitution between the two cash assistance programs, AFDC and UI, by state governments. On the other hand, states that operate relatively generous UI programs also tend to allocate more resources to Medicaid and other in-kind, low-income assistance programs.

Mapping heat in the U.S. financial system

We provide a framework for assessing the build-up of vulnerabilities to the U.S. financial system. We collect forty-six indicators of financial and balance-sheet conditions, cutting across measures of valuation pressures, nonfinancial borrowing, and financial-sector health. We place the data in economic categories, track their evolution, and develop an algorithmic approach to monitoring vulnerabilities that can complement the more judgmental approach of most official-sector organizations. Our approach picks up rising imbalances in the U.S. financial system through the mid-2000s, presaging the financial crisis. We also highlight several statistical properties of our approach: most importantly, our summary measures of system-wide vulnerabilities lead the credit-to-GDP gap (a key gauge in Basel III and related research) by a year or more. Thus, our framework may provide useful information for setting macroprudential policy tools such as the countercyclical capital buffer.

Have American Workers Always Been Low Savers? Patterns of Accumulation Among Working Households, 1885–1910

Based on empirical patterns of annual earnings and saving from new micro-data covering a large sample of American workers around a hundred years ago, we develop a model for simulating the cross-section distribution of wealth at the turn of the twentieth century. Our methodology allows for a direct comparison with the wealth distribution from a sample of families in a comparable part of the contemporary income distribution. Our primary finding is that patterns of wealth accumulation among American workers at the turn of the century bear a striking resemblance to contemporary profiles.

Mapping Heat in the U.S. Financial System: A Summary

This Note reports a selection of results from research intended to quantitatively measure the buildup and reduction of vulnerabilities in the U.S. financial system over time.