Unemployment Insurance with Hidden Savings

Abstract:     
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. The efficient allocation can be implemented by an increasing benefit during unemployment and a constant tax during employment.

Number of Pages in PDF File: 43

Keywords: hidden savings, hidden wealth, repeated moral hazard, unemployment insurance

JEL Classification: D82, D86, J65

Accepted Paper Series