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Adverse Selection and Moral Hazard: Quanitative Implications for Unemployment Insurance

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  • David Fuller

    (University of Iowa)

Abstract

I construct a dynamic contracting model of optimal unemployment insurance with adverse selection and moral hazard. The interaction of the two informational frictions generates novel qualitative and quantitative implications for the provision of unemployment insurance. Qualitatively, for certain agents, incentives in the optimal contract imply expected consumption may actually increase over the duration of unemployment. Quantitatively, the optimal contract reduces costs by over 100%, relative to a stylized version of the current U.S. unemployment insurance system. Compared to a planner who ignores adverse selection and focuses only on moral hazard, the optimal contract achieves an additional 47% of cost savings. Of the extra savings, around 3.2% arises from improved incentives to exert effort, leading to higher expected output. A more efficient allocation of consumption explains the remaining portion of the additional cost savings.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 889.

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Date of creation: 2008
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Handle: RePEc:red:sed008:889

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  1. Mitchell, Matthew & Zhang, Yuzhe, 2010. "Unemployment Insurance with Hidden Savings," MPRA Paper 23214, University Library of Munich, Germany.
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  3. Nicola Pavoni, 2009. "Optimal Unemployment Insurance, With Human Capital Depreciation, And Duration Dependence," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 50(2), pages 323-362, 05.
  4. Pieter A. Gautier & Jose Luis Moraga-Gonzalez & Ronald P. Wolthoff, 2007. "Structural Estimation of Search Intensity: Do Non-Employed Workers Search Enough?," Tinbergen Institute Discussion Papers, Tinbergen Institute 07-071/3, Tinbergen Institute.
  5. Emmanuel Farhi & Iván Werning, 2007. "Inequality and Social Discounting," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 115, pages 365-402.
  6. Rebecca Blank & David Card & Whitney Newey, 1988. "Recent Trends in Insured and Uninsured Unemployment: Is There an Explanation?," Working Papers, Princeton University, Department of Economics, Industrial Relations Section. 623, Princeton University, Department of Economics, Industrial Relations Section..
  7. Narayana Kocherlakota, 2004. "Figuring out the Impact of Hidden Savings on Optimal Unemployment Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 541-554, July.
  8. Robert Shimer & Ivan Werning, 2008. "Liquidity and Insurance for the Unemployed," American Economic Review, American Economic Association, American Economic Association, vol. 98(5), pages 1922-42, December.
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  10. Pries, Michael & Rogerson, Richard, 2009. "Search frictions and labor market participation," European Economic Review, Elsevier, Elsevier, vol. 53(5), pages 568-587, July.
  11. Shavell, Steven & Weiss, Laurence, 1979. "The Optimal Payment of Unemployment Insurance Benefits over Time," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(6), pages 1347-62, December.
  12. Meyer, Bruce D, 1990. "Unemployment Insurance and Unemployment Spells," Econometrica, Econometric Society, Econometric Society, vol. 58(4), pages 757-82, July.
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  14. Andolfatto, David & Gomme, Paul, 1996. "Unemployment insurance and labor-market activity in Canada," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 44(1), pages 47-82, June.
  15. Carl Davidson & Stephen A. Woodbury, 1997. "The Optimal Dole with Risk Aversion, Job Destruction, and Worker Heterogeneity," Upjohn Working Papers and Journal Articles, W.E. Upjohn Institute for Employment Research 97-47, W.E. Upjohn Institute for Employment Research.
  16. Robert E. Hall & Paul R. Milgrom, 2008. "The Limited Influence of Unemployment on the Wage Bargain," American Economic Review, American Economic Association, American Economic Association, vol. 98(4), pages 1653-74, September.
  17. Andrew Atkeson & Robert E Lucas, 2010. "On Efficient Distribution with Private Information," Levine's Working Paper Archive 2179, David K. Levine.
  18. Robert Shimer & Iván Werning, 2006. "On the Optimal Timing of Benefits with Heterogeneous Workers and Human Capital Depreciation," NBER Working Papers 12230, National Bureau of Economic Research, Inc.
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  21. David Fuller & Stephane Auray & Damba Lkhagvasuren, 2013. "Unemployment Insurance Take-up Rates in an Equilibrium Search Model," Working Papers, Concordia University, Department of Economics 13001, Concordia University, Department of Economics.
  22. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(2), pages 412-38, April.
  23. Williamson, Stephen D. & Wang, Cheng, 1999. "Moral Hazard, Optimal Unemployment Insurance, and Experience Rating," Working Papers, University of Iowa, Department of Economics 99-03, University of Iowa, Department of Economics.
  24. Stéphane Auray & David L. Fuller & damba Lkhagvasuren, 2013. "Unemployment Insurance Take-up Rate"s in an Equilibrium Search Model," Working Papers, Centre de Recherche en Economie et Statistique 2013-12, Centre de Recherche en Economie et Statistique.
  25. Hugo A. Hopenhayn & Juan Pablo Nicolini, 2009. "Optimal Unemployment Insurance and Employment History," Review of Economic Studies, Oxford University Press, vol. 76(3), pages 1049-1070.
  26. Bryan Engelhardt & David L. Fuller, 2009. "Efficient Labor Force Participation with Search and Bargaining," Working Papers, College of the Holy Cross, Department of Economics 0909, College of the Holy Cross, Department of Economics, revised Nov 2009.
  27. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, Elsevier, vol. 51(2), pages 367-390, August.
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