State University for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

We utilize panel data from the Health and Retirement Study to investigate the impact of retirement on physical and mental health, life satisfaction, and health care utilization. Because poor health can induce retirement, we instrument for retirement using eligibility for Social Security and employer-sponsored pensions and coverage by the Social Security earnings test. We find strong evidence that retirement improves reported health, mental health, and life satisfaction. In addition, we find evidence of improvements in functional limitations in the long run. Although the impact on life satisfaction occurs within the first 4 years of retirement, many of the improvements in health show up four or more years later, consistent with the view that health is a stock that evolves slowly. We find no evidence that the health improvements are driven by increased health care utilization. In fact, results suggest decreased utilization in some categories.

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Flow earnings in a laboratory experiment decline the further a Brownian state variable, z, evolves from its optimal level z * . Optimal state dependent models predict subjects will pay a fixed cost to return z to z * only when z strays outside a critical inaction region around the optimum. Subjects' average adjustment points are remarkably close to optimal levels, but as in the field they do not establish true "state dependent" inaction regions, suggesting significant "time dependent" components in adjustment rules. Structural estimates of the parameters of a bounded rationality model suggest subjects experience substantial cognitive costs from responding to the state, accounting for these patterns. Cross treatment results suggest that these costs -and the resulting degree of state dependence in adjustment -are powerfully influenced by the volatility of the stochastic process, a finding with potentially important policy implications.