The effect of unemployment on consumption: an experimental analysis

This paper reports on an experiment that investigates the apparently robust phenomenon of over-sensitivity of consumption to current income. Using a particularly simple formulation, we also investigate whether individuals correctly respond to their employment status. We find that subjects over-react. Our data enables us to investigate where this over-sensitivity originates; we conclude that economic agents differ in their ability to plan ahead and understand the dynamic process determining their employment status. However, agents seem able to respond appropriately to "changes" in the parameters governing their decision processes, in that the comparative static predictions of the theory are largely confirmed. Copyright 2004 Royal Economic Society.