Why You Spend Less Long Before You're Laid Off

Job termination and pink slip
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By Kimberly Palmer

Americans, it turns out, are pretty good at predicting their chances of becoming unemployed over the next year, and they tend to spend accordingly. That's according to research by Michael D. Hurd and Susann Rohwedder, researchers at RAND Corp., who analyzed data from over 2,500 households from the RAND American Life Panel. Hurd and Rohwedder found that spending in certain categories, including eating out, clothing and entertainment, tends to decline much more than overall spending in response to fears over unemployment.

At the same time, Hurd and Rohwedder found that people's fixed costs, including rent, utilities and car payments, remain relatively stable amid fears of unemployment. Those expenses are, after all, difficult to adjust quickly, even in the event of an actual layoff. When people felt less secure in their jobs, though, they reduced spending on clothing by about 14 percent, dining out and other forms of entertainment by 11 percent and personal care, which includes things such as haircuts or pedicures, by 12 percent.

%VIRTUAL-WSSCourseInline-884%The data, which was collected at regular intervals between the fall of 2008 and April 2013, showed that even at the beginning of the Great Recession, spending had already started to fall, before the spike in unemployment that would come later, simply because people's expectations about the future had changed. During periods of actual unemployment, Hurd and Rohwedder previously found that people cut back their spending in these categories even more, with a drop of 61 percent on clothing and apparel spending and 49 percent on dining out after two months of unemployment. Overall spending declined just 11 percent after two months of unemployment.

People with a high expectation of unemployment did increase spending in one area, though: public transportation. "It's cheaper to use public transportation than to use your own car, so it's a way of reducing expenses in a relatively painless way," Hurd says. Even if you still have a car, you can pay less for gas and upkeep by using it less.

"If somebody perceives from their work situation that there is a high probability they will become unemployed, they will cut back [on spending] rather than wait until it actually happens," Hurd explains. That finding in itself in a revelation, since researchers previously doubted that people could make such accurate predictions about the future of their employment.

Taking that kind of preventive action to cushion the blow of a potential future layoff is exactly what they should be doing, Hurd says. "It's much easier to reduce spending a little bit over a long period of time than to reduce spending by a lot over a short period," Hurd says. You might hardly notice cutting back on food spending by 5 percent over a year or longer, but suddenly cutting back by 30 percent would be more difficult.

Hurd says he was surprised to find that almost three in four households said they reduced their spending because of the financial crisis. "Since Americans are known for overspending, that sounds very frugal," he says. It's possible that the economic uncertainty motivated that shift, he adds.

Behavioral Finance

One problem with that natural reaction, though, is that when Americans spend less, it can exacerbate the problems of a struggling economy. "It's very clear that in our surveys, people who had no economic shock themselves but were fearful of getting laid off reduce spending. Maybe they have some undefined fears, so the natural response is to draw back, and that is partially responsible for the continued decline in the macro economy," Hurd says. Expectations, he adds, aren't very well understood but are extremely important at both the macro and individual levels.

While Americans might not be able to do much on their own to buoy the overall economy, they can protect their finances by cutting back on their spending in small amounts even before they fear losing their jobs to avoid having to do so suddenly in response to a loss in income. "It would be better for people to spend less early on and to save," says Hurd, adding that people should first assess their own financial situation to determine how much of a buffer they need to have tucked away.

Hurd also recommends spending time thinking about the probabilities of various events occurring, from getting a raise to paying for college to a child. Planning financially for both good and bad events can help avoid unpleasant shocks, he says.

It's also possible to go too far in the other direction, Hurd warns. "Saving is not free -- you can save too much because you're overly pessimistic, and that could be costly also," he says.

Kimberly Palmer is a senior editor for U.S. News Money. She is the author of the new book, "The Economy of You." You can follow her on Twitter @alphaconsumer, circle her on Google Plus or email her at kpalmer@usnews.com.

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