Estimating Life-Cycle Parameters from the Retirement-Consumption Puzzle

Using pseudo-panel data, we estimate the structural parameters of a life—cycle consumption model with discrete labor supply choice. A focus of our analysis is the abrupt drop in consumption upon retirement for a typical household. The literature sometimes refers to the drop, which in the U.S. Consumer Expenditure Survey we estimate to be approximately 14%, as the “retirement—consumption puzzle.” Although a downward step in consumption at retirement contradicts predictions from life—cycle models with additively separable consumption and leisure, or with continuous work-hour options, a consumption jump is consistent with a setup having nonseparable preferences over consumption and leisure and requiring discrete work choices. This paper specifies a life—cycle model with these two elements, and uses the empirical magnitude of the drop in consumption at retirement to identify structural parameters – most importantly, the intertemporal elasticity of substitution. Employing our new estimates, we simulate counterfactual Social Security policy reforms.