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Moral Hazard vs. Liquidity and Optimal Unemployment Insurance

Raj Chetty

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

April 2008

NBER Working Paper No. w13967

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.

Number of Pages in PDF File: 60

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Date posted: April 23, 2008  

Suggested Citation

Chetty, Raj, Moral Hazard vs. Liquidity and Optimal Unemployment Insurance (April 2008). NBER Working Paper No. w13967. Available at SSRN: http://ssrn.com/abstract=1122755

Contact Information

Nadarajan (Raj) Chetty (Contact Author)
University of California, Berkeley - Department of Economics ( email )
549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-643-0708 (Phone)
510-643-0413 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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