This paper explores the links between unemployment, retirement and their associated public insurance programs. It is a contribution to a growing body of literature focused on a better understanding of the labor behavior of advanced—age workers, which has gained importance as the pension crisis looms. The analysis combines the development of a new theoretical model and a detailed exploration of the empirical regularities using the Spanish Muestra Continua de Vidas Laborales (MCVL) dataset. The model is a extension of the standard search model, designed to reproduce the non—stationary environment faced by workers approaching retirement and to explore the interaction of unemployment benefits and retirement pensions. Via calibrated simulations we show that the basic empirical reemployment and retirement patterns can be rationalized as the optimal responses to both the labor market conditions and the institutional incentives. Generous Unemployment Benefits (for durations of up to two years) together with very significant early retirement penalties, make optimal to stay unemployed without searching for large groups of unemployed workers. This moral hazard problem can he substantially alleviated through institutional reform. Setting the early retirement penalties according to the age when the individual withdraws from the labor force (rather than when he/she claims the pension for the first time) seems particularly beneficial. It increases the labor supply, reduces the financial cost for the social security system and generate enough extra resources to compensate for the welfare loss of those unemployed directly hit by the reform.
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