This paper argues that a risk-averse worker’s after-tax reservation wage encodes all the relevant information about her welfare. This insight leads to a novel test for the optimality of unemployment insurance based on the responsiveness of reservation wages to unemployment benefits. Some existing estimates imply significant gains to raising the current level of unemployment insurance but highlight the need for more research on the determinants of reservation wages. Our approach is intuitive and complements those based on Baily’s (1978) test. Some advantages of our test are that it uses less of the structure of the model, it is entirely behavioral and does not require separate risk-aversion estimates, and it is robust to various extensions including worker heterogeneity. Shimer’s research is supported by a grant from the National Science Foundation. Werning is grateful for the hospitality of the Federal Reserve Bank of Minneapolis and Harvard University. We are grateful to The goal of this paper is to develop a test for the optimal level of unemployment insurance

We present general recursive methods to handle environments where privately observed variables are linked over time. We show that incentive compatible contracts are implemented recursively with a threat keeping constraint in addition to the usual temporary incentive compatibility and promise keeping

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

This paper studies the optimal design of an unemployment insurance system in a repeated moral hazard environment where individual’s can save and these savings are private information. This additional source of informational assymetry requires special treatment, here I apply the method developed in Werning (2000). Contrary to existing results in the literature I find that optimal unemployment benefits are not necessarily decreasing with unemployment duration. More importantly, numerical results show, however, that the optimal schedule is increasing but extremely flat, so that constant benefits may provide an excellent approximation to the optimal UI schedule. 1

This paper argues that unemployment insurance increases labor productivity by encouraging workers to seek higher productivity jobs, and by encouraging firms to create those jobs. We use a quantitative model to investigate whether this effect is comparable in magnitude to the standard moral hazard effects of unemployment insurance. Our model economy captures the behavior of the U.S. labor market for high school graduates quite well. When unemployment insurance becomes more generous starting from the current U.S. levels, there is an increase in unemployment similar in magnitude to the micro-estimates, but because the composition of jobs also changes, total output and welfare increase as well. ∗This paper is prepared for the International Seminar on Macroeconomics 1999. Thanks to seminar

In this paper we develop a recursive approach to study efficient allocations in a dynamic moral hazard setting, where agents can borrow and lend and their decisions about effort, consumption and savings are private information. The recursive formulation of the problem is based on a generalized first order approach, whose validity is verified using a parsimonious numerical procedure based on the recursive formulation itself. In contrast with previous findings, we show that the second best allocation is welfare improving with respect to the case where the agents can self insure themselves only through borrowing and lending. Thanks to the recursive formulation, we are able to quantify the efficiency gains in a number of numerical examples. We find that welfare gains are substantial and do not vary monotonically with the credit market return. We also identify the main observational characteristics of the constrained efficient allocation.

This paper studies the effect of human capital depreciation and duration dependence on the design of an optimal unemployment insurance (UI) scheme. Our results partially confirm those obtained in most previous studies: benefits should decrease with unemployment duration. The optimal program also generates two main novel features, which are not present in stationary models. First, if human capital depreciates rapidly enough during unemployment, UI transfers are bounded below by a minimal “assistance” level that arises endogenously in the efficient program. Second, we study the optimality of imposing a history contingent wage tax after reemployment. Our numerical simulations based on the Spanish and US economies show that the wage tax should decrease with the length of worker’s previous unemployment spell, and become a wage subsidy for long-term unemployed workers. As a by-product of our study, we develop a systematic approach suitable for studying recursively a wide range of dynamic moral-hazard problems, and other models with similar characteristics.

This paper is concerned with evaluating alternative unemployment insurance (UI) schemes in a dynamic economy with moral hazard. We consider changes in the size and duration of UI bene…ts, and the e¤ects of experience rating, and use a dynamic contracting approach to determine a benchmark optimal allocation. Radical changes in the current UI system increase welfare, but not by much. A move to full experience rating has distributional e¤ects, but the aggregate e¤ects are negligible. We wish to thank Ian King and conference and seminar participants at the University of Texas

This paper considers the optimal design of unemployment insurance contracts in an environemnt in which workers experience multiple unemployment spells. The environment is suited to study the optimality of employment history related restrictions typically found in existing unemployment insurance programs. We show that when the principal cannot distinguish quits from layoffs, optimality calls for contracts with employment history contingent transfers. In particular, we show that the employment tax an employed worker pays decreases and the unemployment benefit he is entitled to in case of unemployment increases with job duration in the optimal contract. We show that these properties hold both when workers have incentives to quit form good jobs and when they have incentives to take bad jobs.

Studies of the consumption-smoothing benefits of unemployment insurance (UI) have found that the optimal benefit level is very small, perhaps even 0, for conventional levels of risk aversion. In this paper, I derive a formula for the optimal benefit rate in terms of income and price elasticities of unemployment durations, directly inferring risk aversion for the unemployed from their behavioral responses to UI benefits. The optimal rate of social insurance is shown to depend positively on the size of the income elasticity and negatively on the size of the substitution elasticity. I estimate these elasticities using semi-parametric hazard models and variation in UI laws across states and over time. The estimates indicate that income effects account for 70 % of the effectofUIonunemploymentdurations and yield an optimal replacement rate around 50 % of pre-unemployment wages. These results challenge the prevailing view that social safety nets provide minimal welfare gains at a large efficiency cost.