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Consumption Smoothing During the Financial Crisis: The Effect of Unemployment on Household Spending

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Abstract

Because of data limitations, the quantification of consumption smoothing in response to economic shocks has been challenging to investigate empirically. We used monthly data on total household spending, income, and labor force participation to estimate the effects of unemployment on household spending. The data come from the RAND American Life Panel, a standing survey sample that is representative of the United States adult population. We compare monthly spending and income of households prior to unemployment with spending and income following unemployment for up to 40 months. We compare spending and income following re-employment with spending and income while unemployed. We find that by month two of unemployment total household spending per month declined to about 83 percent of pre-unemployment spending. At about 14 months of unemployment, spending began to decline further, reaching 70 percent of pre-unemployment spending by month 30. Income declined much more sharply to 37 percent of its pre-unemployment level by month two of unemployment, with little change after that as the duration of unemployment increased. Thus, consumption does not decline as much as income, so that it is somewhat smoothed relative to income; yet, particularly over long-duration unemployment the decline is substantial. On re-employment, income increased rapidly, spending much less rapidly. As of the third month, high-frequency spending was about 9 percent above its value in the last month of unemployment. It continued to increase until it was about 20 percent higher. Just as with an income drop, spending is somewhat smoothed when income increases.

Key Findings

  • We found that at unemployment, total monthly spending declined rapidly from the $3,560 it averaged during employment to about $2,980, a decline of about 17 percent.
  • Spending remained at that level until about 30 weeks of unemployment when it declined further to about $2,500, or around 70 percent of initial spending.
  • Spending on big-ticket items and other, infrequently purchased items decreased more rapidly than high-frequency expenditures such as those on food.
  • Income decreased much more rapidly than spending to about 37 percent of pre-unemployment levels where it remained unless the duration of the unemployment spell was very long. An implication is that some spending while unemployed was financed out of savings or accumulation of debt.
  • At re-employment, income increased rapidly, much more rapidly than spending.
  • An overall conclusion is that households were able to maintain spending following unemployment at a fairly high percentage of pre-unemployment spending provided the duration of unemployment was moderate.

Citation

Hurd, Michael, and Susann Rohwedder. 2016. “Consumption Smoothing During the Financial Crisis: The Effect of Unemployment on Household Spending.” Ann Arbor, MI. University of Michigan Retirement Research Center (MRRC) Working Paper, WP 2016-353. https://mrdrc.isr.umich.edu/publications/papers/pdf/wp353.pdf

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Project

Paper ID

WP 2016-353

Publication Type

Working Paper

Publication Year

2016