Consumption in the Shadow of Unemployment

Abstract

By how much do employed households reduce their consumption when the aggregate unemployment rate rises? In Spain during the Great Recession a 1 percentage point increase in the unemployment rate was related to a strong drop in household consumption of more than 0.7% per equivalent adult. This reduction is the response of forward-looking agents to downward revisions of their expectations on future income growth rates: the shadow of unemployment. Using consumption panel data that include information on physical quantities, we show that the drop in consumption expenditure was indeed a reduction in quantities, and not a switch to cheaper alternatives.

Keywords: consumption, unemployment, income, life-cycle models, Spain, Great Recession

JEL Classification: E21, E24, D12, D84