Home Production and the Optimal Rate of Unemployment Insurance

By Temel Taşkın


In this paper, we incorporate home production into a quantitative model of unemployment and show that realistic levels of home production have a significant impact on the optimal unemployment insurance rate. Motivated by recently documented empirical facts, we augment an incomplete markets model of unemployment with a home production technology, which allows unemployed workers to use their extra non-market time as partial insurance against the drop in income due to unemployment. In the benchmark model, we find that the optimal replacement rate in the presence of home production is roughly 40% of wages, which is 40% lower than the no home production model’s optimal replacement rate of 65%. The 40% optimal rate is also close to the estimated rate in practice. The fact that home production makes a significant difference in the optimal unemployment insurance rate is robust to a variety of parameterizations and alternative model environments.

Having worked with this type of models, I may show some bias in selecting this paper this week. It is quite natural to think that unemployment insurance should be less generous once you take into account the fact that the unemployed worker does more than doing nothing with his new free time. The contribution here is to quantify the effect, and that is quite difficult as home production is poorly measured. This means also that significant robustness exercises are necessary. While those shown do not show much chnage in the results, more needs to be done to convince me. That includes working with a lower benchmark replacement rate, as the effective rate in the United States it quite lower than the rate when eligible.

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