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Should Unemployment Insurance Vary with the Unemployment Rate? Theory and Evidence

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  • Kroft, Kory
  • Notowidigdo, Matthew J.

Abstract

We study how optimal unemployment insurance (UI) benefits vary over the business cycle by estimating how the moral hazard cost and the consumption smoothing benefit of UI vary with the unemployment rate. We find that the moral hazard cost is procyclical, greater when the unemployment rate is relatively low. By contrast, our evidence suggests that the consumption smoothing benefit of UI is acyclical. Using these estimates to calibrate our job search model, we find that a one standard deviation increase in the unemployment rate leads to a roughly 14 to 27 percentage point increase in the optimal wage replacement rate. We also conduct a model-based estimation of the structural parameters of the model, and we find that virtually all of the cyclical variation in the moral hazard cost and consumption smoothing benefit of UI is due to variation in the responsiveness of search effort as opposed to reservation wages.

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File URL: http://www.clsrn.econ.ubc.ca/workingpapers/CLSRN%20Working%20Paper%20no.%20104%20-%20Kroft%20and%20Notowidigdo.pdf
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Bibliographic Info

Paper provided by Vancouver School of Economics in its series CLSSRN working papers with number clsrn_admin-2012-26.

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Length: 55 pages
Date of creation: 29 Oct 2012
Date of revision: 29 Oct 2012
Publication status: Forthcoming in Canadian Labour Market and Skills Researcher Network (CLSRN) Working Paper Series
Handle: RePEc:ubc:clssrn:clsrn_admin-2012-26

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Web page: http://www.clsrn.econ.ubc.ca/

Related research

Keywords: Unemployment Insurance; Business Cycle; Moral Hazard; Consumption Smoothing;

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References

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  6. Raj Chetty, 2008. "Erratum: Moral Hazard versus Liquidity and Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 116(6), pages 1197-1197, December.
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  12. Johannes F. Schmieder† & Till von Wachter & Stefan Bender, 2011. "The Effects Of Extended Unemployment Insurance Over The Business Cycle: Evidence From Regression Discontinuity Estimates Over Twenty Years," Boston University - Department of Economics - Working Papers Series WP2011-063, Boston University - Department of Economics.
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Citations

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Cited by:
  1. Arash Nekoei & Andrea Weber, 2014. "Does Extending Unemployment Benefits Improve Job Quality?," NRN working papers 2014-04, The Austrian Center for Labor Economics and the Analysis of the Welfare State, Johannes Kepler University Linz, Austria.
  2. Richard Fabling & David C. Maré, 2012. "Cyclical Labour Market Adjustment in New Zealand: The Response of Firms to the Global Financial Crisis and its Implications for Workers," Working Papers 12_04, Motu Economic and Public Policy Research.
  3. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.
  4. Rothstein, Jesse & Valletta, Robert G., 2014. "Scraping By: Income and Program Participation After the Loss of Extended Unemployment Benefits," Institute for Research on Labor and Employment, Working Paper Series, Institute of Industrial Relations, UC Berkeley qt74x2f4jh, Institute of Industrial Relations, UC Berkeley.
  5. Jesse Rothstein, 2011. "Unemployment Insurance and Job Search in the Great Recession," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 43(2 (Fall)), pages 143-213.
  6. Inderbitzin, Lukas & Staubli, Stefan & Zweimüller, Josef, 2013. "Extended Unemployment Benefits and Early Retirement: Program Complementarity and Program Substitution," Economics Working Paper Series 1323, University of St. Gallen, School of Economics and Political Science.
  7. repec:wil:wileco:2012-10 is not listed on IDEAS
  8. De Groot, Nynke & van der Klaauw, Bas, 2014. "The Effects of Reducing the Entitlement Period to Unemployment Insurance Benefits," IZA Discussion Papers 8336, Institute for the Study of Labor (IZA).
  9. Farber, Henry & Valletta, Robert G., 2013. "Do Extended Unemployment Benefits Lengthen Unemployment Spells? Evidence from Recent Cycles in the U.S. Labor Market," IZA Discussion Papers 7347, Institute for the Study of Labor (IZA).
  10. Tatsiramos, Konstantinos & van Ours, Jan C, 2012. "Labor Market Effects of Unemployment Insurance Design," CEPR Discussion Papers 9196, C.E.P.R. Discussion Papers.
  11. Eugster, Beatrix, 2013. "Effects of a higher replacement rate on unemployment durations, employment, and earnings," Economics Working Paper Series 1320, University of St. Gallen, School of Economics and Political Science.
  12. Røed, Knut, 2012. "Active Unemployment Insurance," IZA Policy Papers 41, Institute for the Study of Labor (IZA).
  13. Henry S. Farber & Robert G. Valletta, 2013. "Do extended unemployment benefits lengthen unemployment spells? evidence from recent cycles in the U.S. labor market," Working Paper Series 2013-09, Federal Reserve Bank of San Francisco.

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