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

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 US, 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. We are grateful to Carl Christ, Darrel Cohen, Russell Cooper, Angus Deaton, Karen Dynan, Janice Eberly, Bruce Fallick, James Fergus, Jonas Fisher, Michael Fratantoni, Simon Gilchrist, John Leahy, Jonathan McCarthy, Spencer Krane, Sydney Ludvigson, Greg Mankiw, Randy Mariger, Louis Maccini, David Reifschneider, Martha Starr-McCluer, Daniel Sichel, and seminar participants at Johns Hopkins University, the Board of Governors of the Federal Reserve System, and the 1997 NBER Macroeconomics Annual conference for valuable comments and all sorts of help. The set of RATS programs that generate all of our empirical results, the set of Mathematica programs that generate all of our theoretical results, and a companion paper describing details of our empirical and theoretical methodolgy are all available at Carroll’s home page, http://www.econ.jhu.edu/ccarroll. † NBER and The Johns Hopkins University. Correspondence to Christopher Carroll, Department of Economics, Johns Hopkins University, Baltimore, MD 21218-2685 or [email protected]. ‡ Department of Economics, Johns Hopkins University.