Unemployment Insurance with Hidden Savings

By Matthew Mitchell and Yuzhe Zhang

http://d.repec.org/n?u=RePEc:pra:mprapa:23214&r=dge

This paper studies the design of unemployment insurance when neither the searching effort nor the savings of an unemployed agent can be monitored. If the principal could monitor the savings, the optimal policy would leave the agent savings-constrained. With a constant absolute risk-aversion (CARA) utility function, we obtain a closed form solution of the optimal contract. Under the optimal contract, the agent is neither saving nor borrowing constrained. Counter-intuitively, his consumption declines faster than implied by Hopenhayn and Nicolini [4]. The efficient allocation can be implemented by an increasing benefit during unemployment and a constant tax during employment.

I find this paper very unsettling. The optimal unemployment insurance literature has consistently advocated that benefits should decrease with unemployment tenure, even after finding a job, and this paper puts everything on its head.

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3 Responses to Unemployment Insurance with Hidden Savings

  1. Agent Continuum says:

    Is the link leading to the wrong paper or is there a problem on my side?

  2. Sorry, I linked to the wrong one. It is fixed now.

  3. Yuzhe Zhang says:

    In models where job search is treated as a repeated moral hazard problem, the optimal allocation can be decentralized by many different benefit sequences, together with the agent having access to asset markets. In our paper, we pin down the benefits sequence by making the tax on employment history independent. This leads to the increasing benefit sequence that we calculate.

    If one focuses on the consumption during an unemployment spell, our model has in common with all models of job search as moral hazard that we know of, that consumption falls over the unemployment spell. In fact, with hidden savings, we show that the consumption must fall faster than when savings is observed. The increasing benefit is indicative of the fact that it is easier to motivate poor people (due to longer unemployment) to search, so the benefit is more generous, the longer the unemployment spell.

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