This
paper provides a closed-form solution under labour uncertainty for
optimal consumption and the value function in a finite horizon
life-cycle model
with habit persistence.
We
address the issue of how early retirement may interact with limited
use of financial markets in producing financial hardship later in life,
when
some risks (such as long-term care) are not insured. We argue that the
presence
of financially attractive early retirement schemes in a world of
imperfect
financial and insurance markets can lead to an ‘early retirement trap’.
Indeed,
Europe witnesses many (early) retired
individuals in financial distress. In our analysis we use data on 10
European
countries, which differ in their pension and welfare systems, in
prevailing
retirement age and in households’ access to financial markets. We find
evidence
that an early retirement trap exists, particularly in some Southern and
Central
European countries: people who retired early in life are more likely to
be in
financial hardship in the long run. Our analysis implies that
governments should
stop making early retirement attractive, let retirees go back to work,
improve
access to financial markets and make sure long-term care problems are
adequately insured