Optimal Unemployment Insurance in an Estimated Job Search Model with Savings

This paper estimates a job search model with savings and determines optimal unemployment benefit policy for the estimated model. For observed and unobserved worker characteristics, the estimation strategy relates observed unemployment spell durations to the model implied unemployment hazard rate. The model is estimated on Danish unemployment spell data which include high quality wealth and income information. The estimation shows that Danish workers respond to changes in economic incentives in ways consistent with the model and that the magnitude of the effect of the responses on the unemployment hazard rate is small. Optimal unemployment benefit level policy is determined as a trade-off between providing insurance against consumption fluctuation and the moral hazard of reducing the worker's incentives to search back into employment. Given the estimated low level of moral hazard, the optimal benefit level is quite high even though workers can self-insure via savings. Depending on the interest rate which is effectively the cost of using savings as self-insurance, the optimal replacement rate ranges between 43% and 82%. The policy analysis emphasizes the importance of including transitional dynamics to avoid a significant downward bias associated with a simple steady state comparison analysis.