Borrowing During Unemployment: Unsecured Debt as a Safety Net

This paper explores two related questions: Does unsecured debt help households supplement lost earnings during unemployment, and does limited access to such credit have important welfare implications? These questions have become particularly relevant as consumers increasingly rely on unsecured debt to finance consumption. Growth in unsecured debt has been most striking among the poor. Some researchers suggest that these poor households use this debt to smooth consumption across spells of unemployment. Using panel data from two nationally representative surveys, I examine whether borrowing and consumption are responsive to transitory spells of unemployment. I find that households with some initial wealth do in fact borrow during unemployment spells, increasing unsecured debt on average by 10 cents for each dollar of earnings lost. By contrast, households with low initial wealth do not use unsecured debt to supplement lost earnings. Moreover, data on food and housing consumption indicate that these low asset households have difficulty smoothing consumption during unemployment spells. The results provide strong evidence that low asset households are constrained from unsecured credit markets, suggesting that unsecured credit markets are not a safety net for these most disadvantaged households. JEL classification: D12, E21, E24, E51. † I thank Joseph Altonji, Christopher Taber, and especially Bruce Meyer for all their helpful comments and suggestions. The Joint Center for Poverty Research (JCPR) provided generous support for this work. I am grateful to Jonathan Gruber for sharing his unemployment insurance benefit simulation model. I also benefited from the comments of Gadi Barlevy, Ulrich Doraszelski, Greg Duncan, Gary Engelhardt, Luojia Hu, Brett Nelson, Marianne Page, Henry Siu, Robert Vigfusson, Thomas Wiseman, and the Graduate Fellows at the JCPR. ‡ Department of Economics, 2003 Sheridan Road, Evanston, IL, 60208-2600, [email protected]