Research Discussion Paper – RDP 2021-08 Job Loss, Subjective Expectations and Household Spending

Workers are partly able to predict when they will lose their jobs. However, they typically overpredict the probability of job loss, particularly during economic downturns. The unemployed typically underestimate how long they will be unemployed for. We link these insights on worker expectations of future job prospects to household spending decisions at unemployment. At unemployment, households reduce total spending by around 9 per cent on average. Workhorse consumption models, such as those based on the permanent income hypothesis, predict that households should reduce spending by more in response to unexpected job loss events than to expected ones. Contrary to this, we find that households reduce spending by similar amounts regardless of whether they expect job loss or not. We also find some evidence that the spending response is larger for households that are liquidity constrained, and for households that have been unemployed for longer.