Common sense says that losing a job would have major effects on household budgets. Economic theory says that if a household is adequately insured, through unemployment benefits, savings, home equity, etc., it will be better able to adjust consumption and weather an economic shock.

But what shape do those budget adjustments take? Do people cut spending across all categories, or just some? Do spending reductions continue after re-employment? Does the length of unemployment have a significant impact on future spending choices? The answers to these questions could impact retirement savings and security.

In their 2016 working paper, “Consumption Smoothing During the Financial Crisis: The Effect of Unemployment on Household Spending,” Michael Hurd and Susann Rohwedder use data from the RAND American Life Panel (ALP) to see if common sense and economic theory hold true, and to try and get a better picture of what kind of budget reductions people make when faced with job loss. The ALP offers a detailed look at such adjustments because it matches data collected monthly over many years with a comprehensive measure of household spending—not just food, but also utilities, mortgage payments, clothing, housekeeping supplies, medical expenses, and more.

Focusing on the years 2008 to 2016, which include the end of the Great Recession and subsequent economic recovery, the researchers used data on monthly total household spending, income, and labor force participation to examine what happened to household spending when a household member lost their job.

A look at how households facing unemployment reduced budgets: Most reduced spending, followed by reduced saving, then skimping on bills. Falling behind on rent and mortgage payments was not as common. A small percentage did “none of the above.”

The researchers found that at unemployment:

  • Households reduced total monthly spending by about 17 percent, from an average of $3,560 during employment to $2,980. Big ticket and infrequently purchased items were cut more quickly than high-frequency purchases such as food.
  • That reduction continued for about 30 weeks of unemployment, when it went down about another 13 percent, or to about $2,500.
  • Income decreased much more rapidly than spending to about 37 percent of pre-unemployment levels. It remained at that level unless the duration of the unemployment spell was very long. This might mean that people dipped into savings, accumulated debt, or received family support to fund purchases.

At re-employment the researchers found:

  • Income increased rapidly — more rapidly than spending. As re-employment continued, low-frequency spending increased more than high-frequency spending. People might have maintained reduced food budgets to finance spending on home maintenance postponed during unemployment, for example.
  • Longer-term spending reductions also may reflect efforts to recover from exhausting savings or credit. Or for those people without liquidity constraints, but unemployed for a long time, continued reductions may reflect having to take a job with less pay.

Hurd and Rohwedder write: “…The fact that spending decreases substantially more as unemployment becomes long term suggests that there may be a need for better insurance against long-term unemployment, possibly at the expense of short-term unemployment insurance.  The logic would be that, in the short term, households can finance spending (albeit with some reduction) from their own resources, but in the long term their resources are depleted.”

Such resource depletion would affect retirement security, especially if workers experience job loss close to retirement, leaving less time for savings to recover.

Read the research brief.

Read the working paper.