Full Wealth: The Right Measure of Wealth for Consumption
Lifecycle/PIH theory since Modigliani says consumption should depend on all current and future resources (including financial and human wealth.) • Essentially a stock value of permanent income
from today forward• I call this PDV of all resources:
“Modigliani full wealth” = M
Unprecedented Ability to Measure Full WealthHealth and Retirement Study
Expected present value of resources:
M = Net Worth + Human Wealth• Net Worth = 10 categories of assets less 3 categories
of debt• Human Wealth=
Earnings+Pensions+Social Security+Other Transfers
(deterministic for older households)
Full Wealth is Not Just Scaled-Up Net Worth
Age Profile of Wealth
20
0,0
00
40
0,0
00
60
0,0
00
80
0,0
00
10
0000
0
55 60 65 70 75Age of Household Head
Full Wealth Cash-on-Hand Net Worth
Full Wealth
Net worth
Full Wealth Has Less Variance…
Coefficients of Variation
CV Mean
Full Wealth 0.99 $738,100
Net Worth 1.68 $324,300
Income 1.24 $62,100
Consumption 0.76 $40,300
…and is more equally distributed0
.2.4
.6.8
1
0 .2 .4 .6 .8 1Cumulative population proportion
Lorenz Curve Full Wealth Lorenz Curve Net Worth
Full Wealth
Net worth
Lorenz Curves
The Average Propensity to Consume Out of Full Wealth
Lifecycle model:
• Very limited source of variation in C/M across households
• C/M changes only slowly over time (from mortality, changes in returns expectations, or changes in preferences)
• C/M does not change with income shocks if consumption responds quickly
Which Implies…
Relative to C/Income or C/NetWorth, C/M Should Have:
• Lower variance• Higher covariance over time• Lower correlation with “circumstances” such as:
– Income Profile• Having a pension or the generosity of pension and social security
benefits (income replacement rate in retirement) • Earnings profile over lifetime
– Past Income Shocks
Also ∆(C/M) Should Have:• Lower correlation with past shocks both to income and
to full wealth
And the data says…
Std. Dev. Mean Median CV
C/M 2001 .058 .078 .060 0.74
C/M 2003 .062 .084 .067 0.74
C/NW 2001 3.26 1.05 .221 3.10
C/NW 2003 12.56 2.59 .256 4.85
C/I 2001 1.47 1.22 .828 1.20
C/I 2003 1.37 1.24 .888 1.10
Lower and more consistent variance
Circumstances
• Traditional savings or consumption rates (C/I) have “noise” from circumstances, both cross-sectionally and longitudinally
• Examples:– Households expecting generous DB pension
income will save less than otherwise identical households with little or no DB pension
– Households experiencing a temporary positive income shock will save more that period
Rates of Consumption Out of Alternate Measures of Resources: Income and Full Wealth
20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77 80
Age
Rat
e of
C
onsu
mpt
ion
C/Income C/Full Wealth
Comparison of Baseline to Household with Lower Retirement Income
Income and Net Worth with Different Retirement Incomes
Income Net Worth Baseline Income Baseline Net Worth
`
Consumption Rate Out of Full Wealth with Different Retirement Incomes
Age
Rat
e of
C
onsu
mpt
ion
Lower Retirement Baseline
Comparison of Baseline and Shocked Household
Consumption Rate Out of Income with Income Shock
Age
Rat
e o
f C
on
sum
pti
on
C/I With Shock C/I Baseline
Consumption Rate Out of Full Wealth with Income Shock
AgeC/
M
C/M with Shock C/M Baseline
Testing Circumstances
Circumstance: Generosity of retirement benefits (DB pension and Social Security)
Measure:
RetRatio= Ratio of PV(Pension+Social Security) to Average Earnings Over Ages 45-55
Outcome: C/M is less correlated
Retirement/Earnings Ratio
Bivariate OLS Coefficient & T-stat R2
std(C/M) 2001 on RetRatio 0.003 (1.2) 0.00
std(C/NW) 2001 on RetRatio 0.013*** (6.0) 0.03
std(C/I) 2001 on RetRatio 0.005** (2.1) 0.01
std(C/M) 2003 on RetRatio -0.001 (-0.4) 0.00
std(C/NW) 2003 on RetRatio 0.016*** (4.8) 0.03
std(C/I) 2003 on RetRatio 0.007** (2.3) 0.01
Coefficients represent fraction of standard deviation from mean so can be compared across dependent variables
Income Shocks
Circumstance: Past Income Shock
Measure: Change in Earnings over previous years
Outcome With Levels: results mixed: C/M less correlated than C/I in 2001; less correlated for large shocks in 2003
Income Shocks on Levels of Consumption Rates
2001 Dependent Variable→ std(C/M) std(C/NW) std(C/I)
Independent Variables↓
Y Shock 2000-2001 0.163** (2.0) 0.124* (1.6) -0.263***(-3.2)
Y Shock 1999-2000 -0.064 (-0.7) -0.077 (-0.8) -0.314***(-3.3)
2003 std(C/M) std(C/NW) std(C/I)
Y Shock 2001-2003 -0.003 (0.6) 0.004 (0.4) -0.008 (-1.3)
Y Shock 2000-2001 0.135 (1.4) -0.079 (-0.8) 0.094 (1.0)
2003 with Large Shocks
2003 std(C/M) std(C/NW) std(C/I)
>25% Negative
Y Shock 2001-2003
-0.103
(-0.9)
-0.314***
(-2.7)
0.641***
(6.1)
>25% Positive
Y Shock 2001-2003
0.085
(0.9)
0.161*
(1.7)
-0.390***
(-4.4)
>25% Negative
Y Shock 2000-2001
0.028
(0.2)
-0.310**
(-2.3)
0.311**
(2.5)
>25% Positive
Y Shock 2000-2001
0.126
(1.0)
-0.073
(-0.6)
-0.020
(-0.2)
Change in C/M Less Correlated With Shocks
Dependent Variable→ ∆(C/M) ∆(C/NW) ∆(C/I)
Independent Variables↓
Y Shock 2000-2001 -.050 (-1.3) -.175** (-2.0) .400*** (6.2)
Y Shock 1999-2000 .001 (0.0) .044 (0.4) .168** (2.4)
Changes in M
• Since M is an expected value of current and future resources, any change in M must be unexpected, unlike a change in income
• If consumers adjust relatively quickly to changes in M, then C/M should be relatively invariant to such changes
• Instrument for change in M: Unexpected retirement
Change in C/M Less Affected by Unexpected Changes in M
Dependent Variable→ ∆(C/M) ∆(C/NW) ∆(C/I)
Independent Variable↓
Unexpected Retirement between 2001 & 2003
0.003
(0.4)
-0.077
(-1.0)
0.267***
(3.5)
R2 0.00 0.01 0.02
Conclusion
• Empirically, full wealth, M, and C/M match expected distribution characteristics
• The level of C/M has less correlation with tested circumstances than either C/NW or C/I
• The change in C/M is relatively invariant to recent income and employment shocks and changes in M when compared to C/NW or C/I