What Unresolved Account Activity Means for a Personal Budget

Households make spending decisions based not only on how much income they receive, but also on how certain they are about the resources available to them. Consumption smoothing theory explains why individuals attempt to maintain stable consumption over time by adjusting their savings, borrowing, and asset holdings in response to changes in their financial circumstances. When uncertainty arises regarding available funds, even temporarily, these decisions can be disrupted. Through the use of the life-cycle hypothesis and the permanent income hypothesis, the theory provides a framework that shows how individuals typically attempt to smooth their consumption over time—even as their income changes. Instead of reacting to each variation in income, individuals access credit, put away savings, or raid their assets to maintain their consumption levels.

For consumption smoothing to work properly, the individual must be confident about what his or her available resources are, since consumption smoothing relies on the individual’s understanding of his or her available income. Temporary uncertainty regarding the balance of their account may create difficulties in how to allocate resources when making a decision regarding spending. This type of uncertainty can arise from unresolved account activity, making the question of what is a suspense balance relevant to understanding how temporary limitations on available funds can influence household consumption decisions.

As a result, economists have developed models to illustrate how uncertainty influences individual behaviour regarding consumption smoothing. When making a decision regarding spending, individuals are likely to base their decision on both the expected amount of income they will receive in the future, and on how confident they are about their current financial situation. In times of greater uncertainty about one's available resources, many individuals will decide to withhold their discretionary spending until they feel more certain about their available resources. This is a phenomenon of precautionary saving behaviour; that is, as predicted by economic theory, households will increase their savings and reduce their consumption in response to the uncertainty provided by an uncertain income or the uncertain availability of previously available funds as a way to protect themselves from potential future losses. The presence of this uncertainty tends to reduce their consumption, and therefore, if the contested payment is eventually settled, the intervening uncertainty can lead to lowered spending.

The effect of limited financial buffers can exacerbate the effect of the uncertainty on households as demonstrated by studies conducted by the Federal Reserve Bank of the United States. According to the Federal Reserve's report on the Economic Well-Being of U.S. Households, 37% of adults would be unable to pay an unanticipated expense of $400 with cash or a cash equivalent, which indicates that a significant number of households have relatively low levels of access to liquid assets. For these individuals, the uncertainty of even a nominal balance in their account can affect how they might allocate money toward purchasing groceries, transportation, or other items associated with utilities.

Behavioural economics adds an additional layer of complexity to the discussion surrounding this issue. Traditional economic models operate under the assumption that consumers respond solely to their actual wealth, but psychological considerations also play a vital role in the decisions made by individuals. Consumers exhibit loss aversion as an example of the same phenomenon, wherein consumers give more weight to the possibility of avoiding a loss than they do to the possibility of a gain of the same size. In the case of an uncertain payment, consumers will often conduct themselves as if the payment were never to be available and delay their expenditures until the uncertainty is resolved.

An example occurred shortly after the onset of the COVID-19 pandemic. Many governments throughout the world were providing emergency relief payments to households, but many households experienced multiple weeks of administrative delays before their relief funds became available for use. During the time period prior to actually receiving the funds, many families made conscious decisions to hold off on making non-essential purchases based on their prior expectations of receiving the relief payment. The financial impact brought about as a result of the uncertainty of timing highlighted the manner in which consumer expectations act as a driving force behind consumer consumption decisions.

Disruptions in the payment process can have similar, albeit smaller-scale, effects. In many cases, the borrower may have sufficient long-term employment income for their mortgage payment, however, they may have entered the payment into a suspense account while the mortgage lender obtains the necessary identification information. Because the lender has not received the identification information, the borrower may be uncertain as to whether the mortgage payment has actually been credited toward their account, and consequently, they may delay incurring any other expenses while they are resolving this issue. Delaying additional expenditures creates a situation in which the total amount of reduced spending will typically exceed the original amount of the disputed payment because the household will want to have a financial cushion available in case they experience other financial disruptions.

Over time, these individual responses aggregate into larger macroeconomic effects. Approximately 70% of the GDP of the United States is made up of household expenditures, according to data published by the Bureau of Economic Analysis. As such, given that consumer spending accounts for the majority of overall aggregate demand, when an excessive number of households delay the purchase of products or services within the economy, significant amounts of financial uncertainty can cause a general reduction of economic activity.

Financial institutions are, therefore, investing a significant amount of resources to reduce payment uncertainty. By implementing faster payment technologies, automated payment reconciliation software, and more effective transaction verification procedures, financial institutions are reducing the frictions associated with information that distorts consumer purchasing behaviour. By shortening the period of uncertainty surrounding the funds associated with payments, financial institutions enable households to make more informed, fact-based decisions when making purchases as opposed to making fear-driven decisions based on an assumption regarding the funds associated with uncertain payments.

Economics courses at educational institutions generally maintain that financial markets can operate at their most efficient level when participants share complete, accurate information about the items being traded. The uncertainty regarding the balance of a consumer's bank account provides a real-world application of this premise. Although there may be no permanent economic loss to consumers, incomplete information continues to provide consumers with strong disincentives to spend, thereby leading to precautionary savings in advance of expected or potential loss and delaying the timing of when purchases will be made, all of which, combined, can produce an economic effect that can be substantially larger than the amount of the disputed payment itself.