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Moral Hazard vs. Liquidity and Optimal Unemployment Insurance

  • Raj Chetty

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 in marginal incentives to search ("moral hazard") by combining two empirical strategies. First, I find that increases in benefits have much larger effects on durations for liquidity constrained households. Second, lump-sum severance payments increase durations substantially among constrained households. I derive a formula for the optimal benefit level that depends only on the reduced-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://www.nber.org/papers/w13967.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13967.

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Date of creation: Apr 2008
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Publication status: published as 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.
Handle: RePEc:nbr:nberwo:13967
Note: EFG LS PE
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  1. Stephen Zeldes, . "Consumption and Liquidity Constraints: An Empirical Investigation," Rodney L. White Center for Financial Research Working Papers 24-85, Wharton School Rodney L. White Center for Financial Research.
  2. 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.
  3. Baily, Martin Neil, 1978. "Some aspects of optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 10(3), pages 379-402, December.
  4. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 957-76, October.
  5. 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.
  6. Robert Shimer & Ivan Werning, 2005. "Liquidity and Insurance for the Unemployed," NBER Working Papers 11689, National Bureau of Economic Research, Inc.
  7. Raj Chetty, 2006. "A New Method of Estimating Risk Aversion," American Economic Review, American Economic Association, vol. 96(5), pages 1821-1834, December.
  8. Gary D. Hansen & Ayse Imrohoroglu, 1990. "The Role of Unemployment Insurance in an Economy with Liquidity Constraints and Moral Hazard," UCLA Economics Working Papers 583, UCLA Department of Economics.
  9. Krueger, Alan B. & Meyer, Bruce D., 2002. "Labor supply effects of social insurance," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 33, pages 2327-2392 Elsevier.
  10. Topel, Robert H, 1983. "On Layoffs and Unemployment Insurance," American Economic Review, American Economic Association, vol. 73(4), pages 541-59, September.
  11. Raj Chetty, 2004. "Consumption Commitments, Unemployment Durations, and Local Risk Aversion," NBER Working Papers 10211, National Bureau of Economic Research, Inc.
  12. 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.
  13. Moffitt, Robert, 1985. "Unemployment insurance and the distribution of unemployment spells," Journal of Econometrics, Elsevier, vol. 28(1), pages 85-101, April.
  14. Acemoglu, Daron & Shimer, Robert, 2000. "Productivity gains from unemployment insurance," European Economic Review, Elsevier, vol. 44(7), pages 1195-1224, June.
  15. Raj Chetty & Adam Szeidl, 2006. "Consumption Commitments and Risk Preferences," NBER Working Papers 12467, National Bureau of Economic Research, Inc.
  16. Browning, Martin & Crossley, Thomas F., 2001. "Unemployment insurance benefit levels and consumption changes," Journal of Public Economics, Elsevier, vol. 80(1), pages 1-23, April.
  17. David Card & Raj Chetty & Andrea Weber, 2007. "Cash-On-Hand and Competing Models of Intertemporal Behavior: New Evidence from the Labor Market," The Quarterly Journal of Economics, MIT Press, vol. 122(4), pages 1511-1560, November.
  18. Jonathan Gruber, 1994. "The Consumption Smoothing Benefits of Unemployment Insurance," NBER Working Papers 4750, National Bureau of Economic Research, Inc.
  19. Raj Chetty & Emmanuel Saez, 2008. "Optimal Taxation and Social Insurance with Endogenous Private Insurance," NBER Working Papers 14403, National Bureau of Economic Research, Inc.
  20. Martin Feldstein & James M. Poterba, 1982. "Unemployment Insurance and Reservation Wages," NBER Working Papers 1011, National Bureau of Economic Research, Inc.
  21. 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.
  22. 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.
  23. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 412-38, April.
  24. Robert Shimer & Iván Werning, 2007. "Reservation Wages and Unemployment Insurance," The Quarterly Journal of Economics, MIT Press, vol. 122(3), pages 1145-1185, 08.
  25. 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.
  26. McCall, John J, 1970. "Economics of Information and Job Search," The Quarterly Journal of Economics, MIT Press, vol. 84(1), pages 113-26, February.
  27. Daron Acemoglu & Robert Shimer, 1999. "Efficient Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 107(5), pages 893-928, October.
  28. 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.
  29. 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.
  30. Gruber, Jonathan, 1997. "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, American Economic Association, vol. 87(1), pages 192-205, March.
  31. Bruce D. Meyer, 1988. "Unemployment Insurance And Unemployment Spells," NBER Working Papers 2546, National Bureau of Economic Research, Inc.
  32. 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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