RDP 2021-08: Job Loss, Subjective Expectations and Household Spending 1. Introduction

Job insecurity (or ‘job loss risk’) is a key uncertainty that workers face, particularly during recessions. Elevated levels of job insecurity have been a feature of the economic downturn associated with the COVID-19 pandemic (Figure 1). The extent to which job insecurity persists and affects household spending is important to determining the sustainability of the post-pandemic economic recovery.

It is well-established that job loss is associated with reductions in earning and spending for workers.^[1] But there are many things we do not know about the links between workers' perceptions of their job prospects, actual job outcomes and spending. For example, do workers expect to lose their jobs? How long do the unemployed expect to be without a job? And do these expectations affect household spending behaviour?

Standard consumption theories, such as the permanent income hypothesis (PIH), posit that consumers choose a steady level of consumption in line with their expectations of total lifetime earnings. Under the PIH, households adjust their spending in response to unexpected changes in current income and to changes in their expectations of future income. This implies that households should adjust their spending by more in response to job loss events that are unexpected and/or convey new information about their future job prospects. This suggests that households' subjective beliefs about their current and future income matter to their spending decisions.

In this paper we test these ideas and make several contributions to the literature on job loss, subjective expectations and household spending.

First, we document some stylised facts about subjective expectations regarding future job outcomes. We confirm previous findings that workers have some ability to predict job loss a year ahead, even when controlling for a range of personal characteristics, suggesting that they hold some private information about their future prospects (Dickerson and Green 2012; McGuinness, Wooden and Hahn 2014).

Second, we extend these insights by showing that there are systematic differences between workers' predictions for job loss in the year ahead and actual (ex post) outcomes (we refer to these differences as ‘forecast deviations’). Specifically, there is an intrinsic time-invariant component (or ‘fixed effect’) to workers' expectations of job loss. Most workers persistently overestimate their job loss risk, but some persistently underestimate it.

Third, we show that these job loss forecast deviations co-move with the business cycle – the average worker typically overestimates the probability of job loss by more during economic downturns. And there is a structural component to forecast deviations too – the extent to which workers systematically overestimate the probability of job loss has increased since 2013. This is consistent with elevated job insecurity, lower worker bargaining power and weak wages growth during this time (Foster and Guttmann 2018).

Fourth, we find that individuals' expectations for the duration of unemployment have some predictive power for the actual duration. While workers are overly pessimistic about losing their jobs, the unemployed are too optimistic about finding a job (Mueller, Spinnewijn and Topa 2021).

To the best of our knowledge, these behavioural insights of systematic bias amongst workers are new to the literature. Taken together, these results point to clear violations of standard models of expectation formation, such as the full information rational expectations model. These systematic biases also have implications for job matching and, more generally, household spending behaviour.

We then explore the links between job loss, expectations and spending. We find that the typical household reduces spending by 9 per cent in the year of unemployment. Spending losses are not limited to discretionary spending, with grocery expenditure falling by 7 per cent at unemployment. These consumption losses also extend to the period after unemployment, and are smaller but still exist even when accounting for income losses. These findings suggest that household spending is excessively sensitive to predictable changes in income, which is consistent with previous empirical work (e.g. Gruber 1997; Ganong and Noel 2019) but inconsistent with standard workhorse models, such as the PIH. We find only limited evidence that concerns about future job loss affect spending for those workers that do not actually lose their jobs.

It is well established that unemployment is associated with significant welfare losses (Gruber 1997). Our research goes some way to quantifying the effect on welfare by documenting the size (and persistence) of consumption losses associated with unemployment. For policymakers, our results highlight the costliness of unemployment to households and reaffirm the importance of policies that keep the level and duration of unemployment low.

Footnote

Gruber (1997), Browning and Crossley (2001), Chetty and Szeidl (2007), Christelis, Georgarakos and Jappelli (2015) and Hendren (2017) calculate consumption losses from unemployment in the United States, and Landais and Spinnewijn (2019) does the same for Sweden. [1]