Unemployment Expectations, Jumping (S,s) Triggers, and Household Balance Sheets

Abstract

This paper examines the relationship between household balance sheets, consumer purchases, and expectations. We find few robust empirical relationships between balance sheet measures and spending, but we do find that unemployment expectations are robustly correlated with spending. We then construct a formal model of durables and nondurables consumption with an explicit role for unemployment and for household debt. We find that the model is capable of explaining several empirical regularities which are, at best, unexplained by standard models. Finally, we show that a loosening of liquidity constraints can produce a runup in debt similar to that experienced recently in the United States, and that after such a liberalization consumer purchases show heightened sensitivity to labor income uncertainty, providing a potential rigorous interpretation of the widespread view that the buildup of debt in the 1980s may have played an important role in the weakness of consumption during and after the 1990 recession.