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Optimal Unemployment Insurance with Private Insurance

Listed author(s):
  • Oikonomou, Rigas

I present a model of optimal contracts between firms and workers, under limited commitment and with worker savings. A central feature of the model is that firms can provide insurance against unemployment, by targeting a path of wages that encourages wealth accumulation. I provide an analytical expression for the scope of private insurance measured in the drop of consumption that the worker suffers when the match terminates. I then consider how government policy affects risk sharing through private markets. I find that unemployment benefits should be large and frontloaded. The government has the incentive to drive the allocation to the point where the firm’s participation constraint binds. At this point wages are equal to the match productivity in every period and thus private risk sharing is crowded out. However, the drop in consumption in unemployment is minimized. Moreover, the implications of the theory of optimal contracts are assessed relative to the standard model of heterogeneous households, whereby wealth is utilized for self-insurance purposes. I show that under the optimal UI policy, the contract model and the heterogeneous households model are equivalent.

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File URL: https://mpra.ub.uni-muenchen.de/55726/2/MPRA_paper_55726.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 55726.

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Date of creation: 2013
Handle: RePEc:pra:mprapa:55726
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  1. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2000. "Mutual Insurance, Individual Savings and Limited Commitment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(2), pages 216-246, April.
  2. Jonathan P. Thomas & Tim Worrall, 2007. "Limited Commitment Models Of The Labour Market," Scottish Journal of Political Economy, Scottish Economic Society, vol. 54(5), pages 750-773, November.
  3. 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 118-142, February.
  4. Leena Rudanko, 2011. "Aggregate and Idiosyncratic Risk in a Frictional Labor Market," American Economic Review, American Economic Association, vol. 101(6), pages 2823-2843, October.
  5. Per Krusell & Toshihiko Mukoyama & Ayşegül Şahin, 2010. "Labour-Market Matching with Precautionary Savings and Aggregate Fluctuations," Review of Economic Studies, Oxford University Press, vol. 77(4), pages 1477-1507.
  6. Alexander Karaivanov & Fernando Martin, 2015. "Dynamic Optimal Insurance and Lack of Commitment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(2), pages 287-305, April.
  7. Wang, Cheng & Williamson, Stephen D., 2002. "Moral hazard, optimal unemployment insurance, and experience rating," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1337-1371, October.
  8. Krueger, Dirk & Perri, Fabrizio, 2011. "Public versus private risk sharing," Journal of Economic Theory, Elsevier, vol. 146(3), pages 920-956, May.
  9. Christopher A. Pissarides, 2010. "Why Do Firms Offer 'Employment Protection'?," Economica, London School of Economics and Political Science, vol. 77(308), pages 613-636, October.
  10. Harold L. Cole & Narayana R. Kocherlakota, 2001. "Efficient Allocations with Hidden Income and Hidden Storage," Review of Economic Studies, Oxford University Press, vol. 68(3), pages 523-542.
  11. Rudanko, Leena, 2009. "Labor market dynamics under long-term wage contracting," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 170-183, March.
  12. Engen, Eric M. & Gruber, Jonathan, 2001. "Unemployment insurance and precautionary saving," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 545-579, June.
  13. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 412-438, April.
  14. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877, January.
  15. Allen, Franklin, 1985. "Repeated principal-agent relationships with lending and borrowing," Economics Letters, Elsevier, vol. 17(1-2), pages 27-31.
  16. Gruber, Jonathan, 1997. "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, American Economic Association, vol. 87(1), pages 192-205, March.
  17. Hugo A. Hopenhayn & Juan Pablo Nicolini, 2009. "Optimal Unemployment Insurance and Employment History," Review of Economic Studies, Oxford University Press, vol. 76(3), pages 1049-1070.
  18. Attanasio, Orazio & Rios-Rull, Jose-Victor, 2000. "Consumption smoothing in island economies: Can public insurance reduce welfare?," European Economic Review, Elsevier, vol. 44(7), pages 1225-1258, June.
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