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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. Carroll, Christopher D, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, MIT Press, vol. 112(1), pages 1-55, February.
  2. Robert Shimer & Ivan Werning, 2006. "Reservation Wages and Unemployment Insurance," NBER Working Papers 12618, National Bureau of Economic Research, Inc.
  3. 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.
  4. Raj Chetty & Emmanuel Saez, 2010. "Optimal Taxation and Social Insurance with Endogenous Private Insurance," American Economic Journal: Economic Policy, American Economic Association, vol. 2(2), pages 85-114, May.
  5. Martin Browning & Thomas Crossley, . "Unemployment Insurance Benefit Levels and Consumption Changes," Canadian International Labour Network Working Papers 25, McMaster University.
  6. 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.
  7. 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.
  8. Rasmus Lentz, 2003. "Optimal Unemployment Insurance in an Estimated Job Search Model with Savings," CAM Working Papers 2004-10, University of Copenhagen. Department of Economics. Centre for Applied Microeconometrics.
  9. 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.
  10. Meyer, Bruce D, 1990. "Unemployment Insurance and Unemployment Spells," Econometrica, Econometric Society, vol. 58(4), pages 757-82, July.
  11. Acemoglu, Daron & Shimer, Robert, 2000. "Productivity gains from unemployment insurance," European Economic Review, Elsevier, vol. 44(7), pages 1195-1224, June.
  12. 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.
  13. Hansen, G.D. & Imrohoroglu, A., 1990. "The Role Of Unemployment Insurance In An Economy With Liquidity Constraints And Moral Hazard," Papers 21, California Los Angeles - Applied Econometrics.
  14. Topel, Robert H, 1983. "On Layoffs and Unemployment Insurance," American Economic Review, American Economic Association, vol. 73(4), pages 541-59, September.
  15. Raj Chetty, 2006. "A New Method of Estimating Risk Aversion," American Economic Review, American Economic Association, vol. 96(5), pages 1821-1834, December.
  16. 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.
  17. Zeldes, Stephen P, 1989. "Consumption and Liquidity Constraints: An Empirical Investigation," Journal of Political Economy, University of Chicago Press, vol. 97(2), pages 305-46, April.
  18. Gruber, Jonathan, 1997. "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, American Economic Association, vol. 87(1), pages 192-205, March.
  19. Acemoglu, D. & Shimer, R., 1997. "Efficient Unemployment Insurance," Working papers 97-9, Massachusetts Institute of Technology (MIT), Department of Economics.
  20. Moffitt, Robert, 1985. "Unemployment insurance and the distribution of unemployment spells," Journal of Econometrics, Elsevier, vol. 28(1), pages 85-101, April.
  21. Robert Shimer & Iván Werning, 2005. "Liquidity and insurance for the unemployed," Staff Report 366, Federal Reserve Bank of Minneapolis.
  22. Raj Chetty & Adam Szeidl, 2006. "Consumption Commitments and Risk Preferences," NBER Working Papers 12467, National Bureau of Economic Research, Inc.
  23. 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.
  24. Hopenhayn, H. & Nicolini, P.J., 1996. "Optimal Unemployment Insurance," RCER Working Papers 421, University of Rochester - Center for Economic Research (RCER).
  25. Feldstein, Martin & Poterba, James, 1984. "Unemployment insurance and reservation wages," Journal of Public Economics, Elsevier, vol. 23(1-2), pages 141-167.
  26. Jonathan Gruber, 1994. "The Consumption Smoothing Benefits of Unemployment Insurance," NBER Working Papers 4750, National Bureau of Economic Research, Inc.
  27. 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.
  28. McCall, John J, 1970. "Economics of Information and Job Search," The Quarterly Journal of Economics, MIT Press, vol. 84(1), pages 113-26, February.
  29. Alan B. Krueger & Bruce D. Meyer, 2002. "Labor Supply Effects of Social Insurance," NBER Working Papers 9014, National Bureau of Economic Research, Inc.
  30. Baily, Martin Neil, 1978. "Some aspects of optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 10(3), pages 379-402, December.
  31. Raj Chetty, 2004. "Consumption Commitments, Unemployment Durations, and Local Risk Aversion," NBER Working Papers 10211, National Bureau of Economic Research, Inc.
  32. 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.
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