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Optimal Unemployment Insurance in an Estimated Job Search Model with Savings

  • Rasmus Lentz

    (Boston University)

This paper estimates a job search model with savings and determines optimal unemployment benefit policy for the estimated model. For observed and unobserved worker characteristics, the estimation strategy relates observed unemployment spell durations to the model implied unemployment hazard rate. The model is estimated on Danish unemployment spell data which include high quality wealth and income information. The estimation shows that Danish workers respond to changes in economic incentives in ways consistent with the model and that the magnitude of the effect of the responses on the unemployment hazard rate is small. Optimal unemployment benefit level policy is determined as a trade-off between providing insurance against consumption fluctuation and the moral hazard of reducing the worker's incentives to search back into employment. Given the estimated low level of moral hazard, the optimal benefit level is quite high even though workers can self-insure via savings. Depending on the interest rate which is effectively the cost of using savings as self-insurance, the optimal replacement rate ranges between 43% and 82%. The policy analysis emphasizes the importance of including transitional dynamics to avoid a significant downward bias associated with a simple steady state comparison analysis.

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Paper provided by University of Copenhagen. Department of Economics. Centre for Applied Microeconometrics in its series CAM Working Papers with number 2004-10.

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Length: 36 pages
Date of creation: Mar 2003
Date of revision:
Handle: RePEc:kud:kuieca:2004_10
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  1. Wang, Cheng & Williamson, Stephen D., 2002. "Moral Hazard, Optimal Unemployment Insurance and Experience Rating," Staff General Research Papers 10133, Iowa State University, Department of Economics.
  2. Baily, Martin Neil, 1978. "Some aspects of optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 10(3), pages 379-402, December.
  3. Hopenhayn, H. & Nicolini, P.J., 1996. "Optimal Unemployment Insurance," RCER Working Papers 421, University of Rochester - Center for Economic Research (RCER).
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  7. Steven Shavell & Laurence Weiss, 1978. "The Optimal Payment of Unemployment Insurance Benefits over Time," Cowles Foundation Discussion Papers 503, Cowles Foundation for Research in Economics, Yale University.
  8. Robert Shimer & Ivan Werning, 2008. "Liquidity and Insurance for the Unemployed," American Economic Review, American Economic Association, vol. 98(5), pages 1922-42, December.
  9. Frederiksen, A. & Graversen, E.K. & Smith, N., 2001. "Overtime Work, Dual Job Holding and Taxation," Papers 01-7, Aarhus School of Business - Department of Economics.
  10. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
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  12. Bruce D. Meyer, 1988. "Unemployment Insurance And Unemployment Spells," NBER Working Papers 2546, National Bureau of Economic Research, Inc.
  13. 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, vol. 7(3), pages 541-554, July.
  14. Rasmus Lenz & Torben Tranæs, . "Job Search and Savings: Wealth Effects and Duration Dependence," EPRU Working Paper Series 01-10, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  15. JOSEPH Gilles and WEITZENBLUM Thomas, 2001. "Unemployment Insurance and Precautionary Savings : Transitional Dynamics vs. Steady State Equilibrium," Computing in Economics and Finance 2001 96, Society for Computational Economics.
  16. Heckman, James J. & Singer, Burton, 1984. "Econometric duration analysis," Journal of Econometrics, Elsevier, vol. 24(1-2), pages 63-132.
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  18. Flemming, J. S., 1978. "Aspects of optimal unemployment insurance : Search, leisure, savings and capital market imperfections," Journal of Public Economics, Elsevier, vol. 10(3), pages 403-425, December.
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