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Optimal Unemployment Insurance: Transitional Dynamics vs. Steady State

  • Gilles Joseph

    (Universite Catholique de Louvain)

  • Thomas Weitzenblum

    (Universite Paris-Dauphine and CEPREMAP)

In this study, we ask whether the presence of precautionary savings substantially reduces the optimal replacement rate in an European economy type characterized by high unemployment benefits and moral hazard. We build a simple job search model calibrated on French data and, in line with previous studies, find that the optimality criterion based on comparisons of steady states leads to a low optimal ratio. Yet, this result ignores potential transitional costs due to the necessity for agents to increase their savings and reduce their consumption whenever the ratio is cut. We therefore build a dynamic model taking full account of the transition, and show that a reduction in benefits reduces welfare. Even though the long-run optimal replacement rate is lower than the current one, transitional costs dominate long-run gains. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/S1094-2025(03)00021-8
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 6 (2003)
Issue (Month): 4 (October)
Pages: 869-884

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Handle: RePEc:red:issued:v:6:y:2003:i:4:p:869-884
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  18. Mark Huggett, 1995. "The one-sector growth model with idiosyncratic shocks," Discussion Paper / Institute for Empirical Macroeconomics 105, Federal Reserve Bank of Minneapolis.
  19. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
  20. Atkinson, Anthony B & Micklewright, John, 1991. "Unemployment Compensation and Labor Market Transitions: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 29(4), pages 1679-1727, December.
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  25. Cahuc, Pierre & Lehmann, Etienne, 2000. "Should unemployment benefits decrease with the unemployment spell?," Journal of Public Economics, Elsevier, vol. 77(1), pages 135-153, July.
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