The Effect of Health on Consumption Decisions in Later Life: Evidence from the UK

The analysis in this paper focuses on the impact of health on the savings and consumption decisions of the elderly. In principle, there are at least five alternative channels through which health may affect consumption and savings. Ill health may affect both consumption capacities and needs while the risk of deteriorating health might increase subjective mortality expectations inducing higher consumption. Conversely ill health may induce lower consumption and an increase in precautionary savings given that agents may anticipate increased consumption needs following a negative health shock. Our main objective in this paper is to describe how consumption decisions of the elderly adjust to health changes and to disentangle of the different channels through which consumption responds to health changes. To identify the effect of health on consumption and saving decisions we use data from the British Household Panel Survey and the English Longitudinal Survey of Ageing (ELSA) and we estimate a series of regression models which relate health changes to observed consumption changes. Our findings suggest that there are significant adjustments in the composition of consumption following an illness onset. These adjustments reflect mainly the combined effect of increased costs associated with illness onset as well as the effect of constraints on opportunity to spend associated with illness onset.