Consumption dynamics and the insurance value of benefits

Context
A central role of the welfare benefits system is to protect families from hardship when they experience an unexpected shock. For instance, someone who loses their job will often become eligible for a benefit payment. This means that they still have some income - thereby partially mitigating the reduction they have to make to their expenditure and living standards.

How successful the benefit system is in insuring people against hardship depends on a number of factors, beyond simply the overall level of support provided. First, how easily adjustable is people's spending after they experience an unexpected fall in income, and over what time frame do inflexible items remain hard to adjust? For instance, if rent or mortgage payments are large fractions of people's budgets and hard to adjust, any adjustment to spending will have to be more lopsided, and concentrated on things which may lead to particular hardship (e.g. food). Second, are the payments received in a timely way? The period immediately after a loss in earnings may be a time of particular difficulty, in part due to spending commitments being at their most inflexible. A significant wait period prior to receiving the first benefit payment therefore can lead to a large fall in living standards. Third, to what extent are people able to make other adjustments - e.g., drawing down on their savings or borrowing - to maintain living standards following a drop in earnings?

These issues connect to central live policy debates. The 'five week wait' for the first payment of Universal Credit has proven highly controversial, and the pandemic has brought renewed attention to the relatively thin safety net, by international standards, that we have in the UK.

Aims and objectives
Our work will directly speak to these questions with rigorous evidence using bank account data. We will study how people change their spending when they lose their job and begin claiming benefits, showing how their total spending changes and the extent to which hard-to-adjust costs lead to lopsided reductions in spending across people's budgets; whether spending falls are largest during the wait period for benefits (indicating particular hardship); and to what extent changes differ across groups. In addition, we will measure the extent to which families show signs of financial distress, such as missing bill payments and the use of payday loans, as well as which groups can rely on a buffer of savings to help them over the period.

Our work will provide new evidence on for whom and at which point after an income shock economic hardship is most severe. This in turn will enable us to learn about how the benefit system could be improved. We will estimate the impacts of potential reforms, such as reducing the wait period before the first payment, and of providing greater levels of support at the beginning of a claim (including for specific spending commitments - in particular housing costs).

Applications and benefits
From a scientific point of view, our approach will build on and extend existing applied microeconomics research on the design of social insurance programmes. Moreover, the research questions are central to the operation of welfare policy and hence to poverty and inequality, and so the findings will be relevant to a broad range of social scientists including those from economics, social policy and sociology. Our impact plan includes a focus on engaging with all these fields.

We will provide policymakers with rigorous empirical evidence to feed into central decisions around welfare policy, including by explicitly analysing alternative policy options. We will exploit our close relationships with key policymakers (a number of whom are already aware of and supportive of our proposal - see for example the enclosed letters of support) to ensure we produce the most useful policy guidance with maximum impact.