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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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  2. Camille Landais & Pascal Michaillat & Emmanuel Saez, 2011. "Optimal Unemployment Insurance Over the Business Cycle," CEP Discussion Papers dp1078, Centre for Economic Performance, LSE.
  3. Raj Chetty, 2008. "Moral Hazard versus Liquidity and Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 116(2), pages 173-234, 04.
  4. Rasmus Lentz, 2009. "Optimal Unemployment Insurance in an Estimated Job Search Model with Savings," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(1), pages 37-57, January.
  5. Johannes F. Schmieder & Till M. von Wachter & Stefan Bender, 2012. "The Effects of Extended Unemployment Insurance over the Business Cycle: Evidence from Regression Discontinuity Estimates Over Twenty Years," NBER Working Papers 17813, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. repec:wil:wileco:2012-10 is not listed on IDEAS
  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. 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).
  4. Inderbitzin, Lukas & Staubli, Stefan & Zweimüller, Josef, 2013. "Extended Unemployment Benefits and Early Retirement: Program Complementarity and Program Substitution," IZA Discussion Papers 7330, Institute for the Study of Labor (IZA).
  5. Jesse Rothstein, 2011. "Unemployment Insurance and Job Search in the Great Recession," NBER Working Papers 17534, National Bureau of Economic Research, Inc.
  6. Røed, Knut, 2012. "Active Unemployment Insurance," IZA Policy Papers 41, Institute for the Study of Labor (IZA).
  7. 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 qt74x2f4jh, Institute of Industrial Relations, UC Berkeley.
  8. Tatsiramos, Konstantinos & van Ours, Jan C, 2012. "Labor Market Effects of Unemployment Insurance Design," CEPR Discussion Papers 9196, C.E.P.R. Discussion Papers.
  9. 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.
  10. 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.
  11. 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.
  12. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.

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