28 Pages Posted: 3 Nov 2005
Date Written: January 22, 2008
We study the optimal design of unemployment insurance for workers sampling job opportunities over time. We focus on the optimal timing of benefits and the desirability of allowing workers to freely access a riskless asset. When workers have constant absolute risk aversion preferences it is optimal to use a very simple policy: a constant benefit during unemployment, a constant tax during employment that does not depend on the duration of the spell, and free access to savings using a riskless asset. Away from this benchmark, for constant relative risk aversion preferences, the welfare gains of more elaborate policies are minuscule. Our results highlight two largely distinct roles for policy toward the unemployed: (a) ensuring workers have sufficient liquidity to smooth their consumption; and (b) providing unemployment benefits that serve as insurance against the uncertain duration of unemployment spells.
Keywords: optimal unemployment insurance, consumption smoothing, duration of unemployment benefits, sequential search
JEL Classification: D82, J65
Suggested Citation: Suggested Citation
Werning, Iván and Shimer, Robert, Liquidity and Insurance for the Unemployed (January 22, 2008). MIT Department of Economics Working Paper No. 05-23; American Economic Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=840124