Consumer spending during unemployment: Positive and normative implications
Peter Ganong, Assistant Professor, Harris School of Public Policy, University of Chicago
Pascal Noel, Ph.D. Candidate in Economics, Harvard University
We study the spending of unemployment insurance (UI) recipients using de-identified data from nearly 200,000 bank accounts. Spending on nondurables falls by 6% at the onset of unemployment, is largely stable during UI receipt, and then falls by an additional 13% at benefit exhaustion. Using cross-state variation, we show that spending responds to the level of UI benefits and drops exactly when UI benefits are exhausted.
We explore the positive and normative implications of the drop in spending at UI exhaustion. From a positive perspective, our finding that spending responds to a large and predictable income drop sharpens an existing puzzle of the empirical excess sensitivity of spending to income, which is at odds with predictions from rational models. A model which includes hand-to-mouth consumers (Campbell and Mankiw 1989) as well as a model of inattentive consumers (Gabaix 2016) are able to generate a drop at exhaustion. In normative terms, because spending is so much lower after UI exhaustion than during UI receipt, the consumption-smoothing gains from extending UI benefits are at least three times as big as the gains from raising the level of UI benefits.