Consumption, employment uncertainty, and capital losses

From a household point of view the two major changes associated with the economic disruption of the last eighteen months are, first, that the unemployment rate and presumably the risk of unemployment have risen sharply, and secondly, that there have been large declines in asset prices. It is obviously not possible to say how far either of these changes is permanent, but there is a risk that steady state unemployment may increase, at least for a substantial period of time. Equally, given that asset prices in 2007 were unusually high, it seems most unlikely that they will rapidly recover to the levels of two years ago. This study explores the implications of these two changes for household behaviour. The analysis is conducted using the National Institute Benefit and Tax Model (NIBAX) made available to the Department for Work and Pensions and HM Revenue and Customs. NIBAX is a simulation model of household behaviour, which operates on the assumption that households plan for the future. This planning is considered to take account of the framework of taxes and benefits that exists, in the light of practical considerations regarding the uncertainty of the future, and the importance of credit constraints. Thus the results tell us how people would behave if they did understand their economic environment and planed rationally for an uncertain future. The structure of this paper is as follows. First, we provide an outline description of the NIBAX model. We then discuss the simulation framework and present simulation results. It turns out that the effects of capital losses depend very much on whether labour supply is exogenous and this is illustrated. Finally conclusions are drawn.