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Moral Hazard versus Liquidity and Optimal Unemployment Insurance

  • Chetty, Raj

This paper presents new evidence on why unemployment insurance (UI) benefits affect search behavior and develops a simple method of calculating the welfare gains from UI using this evidence. I show that 60 percent of the increase in unemployment durations caused by UI benefits is due to a “liquidity effect†rather than distortions on marginal incentives to search (“moral hazardâ€) by combining two empirical strategies. First, I find that increases in benefits have much larger effects on durations for liquidityâ€constrained households. Second, lumpâ€sum severance payments increase durations substantially among constrained households. I derive a formula for the optimal benefit level that depends only on the reducedâ€form liquidity and moral hazard elasticities. The formula implies that the optimal UI benefit level exceeds 50 percent of the wage. The “exact identification†approach to welfare analysis proposed here yields robust optimal policy results because it does not require structural estimation of primitives.

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File URL: http://dash.harvard.edu/bitstream/handle/1/9751256/Chetty_MoralHazard.pdf
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Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 9751256.

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Date of creation: 2008
Date of revision:
Publication status: Published in Journal of Political Economy
Handle: RePEc:hrv:faseco:9751256
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Web page: http://www.economics.harvard.edu/

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  1. David S. Johnson & Jonathan A. Parker & Nicholas S. Souleles, 2004. "Household Expenditure and the Income Tax Rebates of 2001," NBER Working Papers 10784, National Bureau of Economic Research, Inc.
  2. Rasmus Lentz & Torben Tranas, 2005. "Job Search and Savings: Wealth Effects and Duration Dependence," Journal of Labor Economics, University of Chicago Press, vol. 23(3), pages 467-490, July.
  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. Martin Feldstein & Daniel Altman, 2007. "Unemployment Insurance Savings Accounts," NBER Chapters, in: Tax Policy and the Economy, Volume 21, pages 35-64 National Bureau of Economic Research, Inc.
  5. Richard Blundell & Luigi Pistaferri & Ian Preston, 2004. "Consumption inequality and partial insurance," IFS Working Papers W04/28, Institute for Fiscal Studies.
  6. David Card & Raj Chetty & Andrea Weber, 2006. "Cash-on-Hand and Competing Models of Intertemporal Behavior: New Evidence from the Labor Market," NBER Working Papers 12639, National Bureau of Economic Research, Inc.
  7. Gruber, Jonathan, 1997. "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, American Economic Association, vol. 87(1), pages 192-205, March.
  8. Moffitt, Robert, 1985. "Unemployment insurance and the distribution of unemployment spells," Journal of Econometrics, Elsevier, vol. 28(1), pages 85-101, April.
  9. Stephen P. Zeldes, . "Consumption and Liquidity Constraints: An Empirical Investigation," Rodney L. White Center for Financial Research Working Papers 16-88, Wharton School Rodney L. White Center for Financial Research.
  10. Yolanda K. Kodrzycki, 1998. "Effects of employer-provided severance benefits on reemployment outcomes," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 41-68.
  11. Hans G. Bloemen & Elena G. F. Stancanelli, 2005. "Financial Wealth, Consumption Smoothing and Income Shocks Arising from Job Loss," Economica, London School of Economics and Political Science, vol. 72(3), pages 431-452, 08.
  12. Christopher D Carroll, 1990. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," Economics Working Paper Archive 371, The Johns Hopkins University,Department of Economics, revised Aug 1996.
  13. Feldstein, Martin S, 1978. "The Effect of Unemployment Insurance on Temporary Layoff Unemployment," American Economic Review, American Economic Association, vol. 68(5), pages 834-46, December.
  14. Hansen, Gary D & Imrohoroglu, Ayse, 1992. "The Role of Unemployment Insurance in an Economy with Liquidity Constraints and Moral Hazard," Journal of Political Economy, University of Chicago Press, vol. 100(1), pages 118-42, February.
  15. Anderson, Patricia M & Meyer, Bruce D, 1997. "Unemployment Insurance Takeup Rates and the After-Tax Value of Benefits," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 913-37, August.
  16. Hurst, Erik & Stafford, Frank, 2004. "Home Is Where the Equity Is: Mortgage Refinancing and Household Consumption," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(6), pages 985-1014, December.
  17. Cullen, Julie Berry & Gruber, Jonathan, 2000. "Does Unemployment Insurance Crowd Out Spousal Labor Supply?," Journal of Labor Economics, University of Chicago Press, vol. 18(3), pages 546-72, July.
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