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A pecking order of household finance

Journal: Oxford Economic Papers

Date: 2025

Author: Declan French

Abstract:
How do households cope with economic shocks? In this article, I provide empirical evidence and theoretical grounding for a pecking order of coping methods using data from the UK Understanding Society COVID-19 Study. I find that there is a typical household finance ordering of responses to income loss. Almost two-thirds (65 per cent) of households first reduce spending then these households typically proceed to draw down savings (59 per cent) and their most common next response is relying on family and friends (21 per cent). Deviations from this ordering occur because certain coping methods are of ten unavailable—those households not reducing spending are already struggling and those without savings have nothing to drawdown. Receiving financial assistance from family and friends is also more common than some authors suggest. Lastly, I find that the costs of informal borrowing are influenced by plausible social factors. My results are informative for policies to promote resilience during crises.

Link: Google Scholar

Background and Context

Research Question

How do households cope with economic shocks and is there a predictable "pecking order" of financial responses?

Data Source

UK Understanding Society COVID-19 Study tracking 6,815 households from April 2020 to September 2021.

Theoretical Framework

Adapts corporate finance "pecking order" theory to household financial decision-making using stochastic control models.

Households Follow a Predictable Pecking Order When Facing Financial Shocks

Reduce Spending 65% Use Savings 59% Family Help 21% Typical Household Coping Order
  • Most households follow a predictable sequence when earnings fall during economic crises.
  • First step: 65% of households reduce their spending as initial response to shock.
  • Second step: 59% then draw down savings when spending cuts are insufficient.
  • Third step: 21% turn to family and friends for financial assistance after other options.

Deviations from Typical Order Occur Because Coping Methods Are Unavailable

Why Households Deviate Already Struggling Cannot reduce spending further 35% skip step 1 No Savings Nothing to draw down 41% skip step 2 No Family Support Cannot seek family help 79% skip step 3 Coping Methods Often Unavailable
  • Not all households can follow the typical sequence due to practical constraints.
  • 35% cannot reduce spending because their expenditure is already at subsistence levels.
  • 41% cannot use savings because they have no savings or investments to draw upon.
  • 79% cannot rely on family help due to lack of supportive family relationships.

Spending Reduction Most Common Response But Usage Varies Significantly

  • Reducing spending is overwhelmingly the most common coping strategy at 91.1% usage rate.
  • Using savings follows at 47.6%, confirming it as second most popular financial response.
  • Family and friends assistance used by 12.4%, more than formal credit from banks.
  • Other strategies like increased work or welfare benefits used by less than 7%.

Sequential Choices Show Clear Progression Through Financial Options

  • First choice dominated by spending reduction (65%) with savings use secondary (20%).
  • Second choice shifts to savings drawdown (59%) for those who initially reduced spending.
  • Third choice shows family and friends becoming more prominent option (21%).
  • Pattern demonstrates households exhaust cheaper options before moving to costlier alternatives.

Family Support Networks Drive Informal Borrowing More Than Financial Constraints

  • Strong family support significantly increases likelihood of receiving financial help from relatives.
  • Friend support shows negative coefficient, indicating informal borrowing primarily occurs within families.
  • Lack of savings or income from investments reduces probability of family borrowing.
  • Results suggest family assistance is not "last resort" but depends on social capital.

Contribution and Implications

  • First comprehensive empirical evidence of household financial pecking order during major economic crisis.
  • Challenges conventional wisdom that family borrowing is always a "last resort" financial option.
  • Demonstrates that financial fragility often prevents households from following optimal coping sequences.
  • Provides framework for designing better crisis support policies targeting actual household behavior patterns.
  • Shows importance of social networks in financial resilience, with policy implications for inequality.

Data Sources

  • Coping methods usage chart based on descriptive statistics from Table 1 of article.
  • Sequential choices visualization derived from percentages shown in Figure 2 flow diagram.
  • Factors affecting family borrowing chart uses probit coefficients from Table 2 regression results.
  • Conceptual visualizations synthesize findings from theoretical framework and empirical analysis sections.