Consumption responses to unemployment shocks

This paper analyzes consumption responses to unexpected unemployment shocks in a Life-Cycle Model (LCM) using subjective (un)employment probabilities. Prior papers have either distinguished between the degree of unexpectancy or the degree of persistency. Our proposed method takes into account both unexpectancy through subjective job loss expectations and persistency through subjective job finding expectations as well as non-liquidity driven age effects. Panel data with detailed information on a wide array of spending categories allows us to analyze the effects of job loss on intratemporal substitution from work-related to leisure-related spending and from spending to home production. Our results suggest substantial decreases in spending (about 34%) due to job loss shocks. We find little evidence for consistently increasing spending on leisure activities after a job loss shock, but we find reasonable evidence for shifts from spending to home production. However, this shift is only small compared to the total spending drop.

JEL codes: C33, D1, H55, J22, J26
Keywords: Consumption, Home production, Job loss, Unexpectancy, Permanency, Subjective expectations