Mar 13, 2010
What's the Optimal Level of Unemployment Benefits?
Given all the recent discussion implying that unemployment compensation increases job search time, and that is an unequivocal bad, I've been meaning to write about the benefits of unemployment compensation. That job search time goes up as a result of unemployment compensation is not necessarily bad if it leads to better matches between workers and employment. And there are other benefits of unemployment compensation as well, but Raj Chetty has this covered already in an interview from the January 2009 AEA meetings on Vox EU so I'll turn it over to him:
Public finance: theory, evidence and policy, Raj Chetty Interviewed by Romesh Vaitilingam, Vox EU: Romesh Vaitilingham: ...My name is Romesh Vaitilingham, and today's interview is with Professor Raj Chetty of Harvard University. Raj ... began by giving us an introduction to the issues that arise in his research.
Q. For how long should workers receive unemployment insurance benefits?
A. In most countries, unemployment insurance benefits can be collected for a limited amount of time — 6 months in the United States, although that is often extended during recessions, as it has been now. The conventional view is that limiting benefits prevents workers from gaming the system. While this idea seems appealing, in my research, I found that limiting benefits is not optimal.
When you think more about it, limiting benefits makes less sense. After all, those with the longest unemployment spells are those with largest losses from foregone earnings. In other insurance arrangements we see the reverse: In health or car insurance, you are not covered for the small expenses, but are fully covered for the larger ones.
We should remain mindful of the incentive effects of unemployment insurance benefits and prevent anyone from manipulating the system. However, instead of limiting the duration of benefits, we need to get the level of benefits right.
Q. What determines the right level of benefits?
A. The level of unemployment insurance benefits must trade off the severity of the moral-hazard incentive effects
with the desire to help unemployed workers. Both sides of the equation depend on how well workers can cope with transitory losses of income while they are out of work. Typically, if workers have good access to liquidity, from their savings or access to credit, then optimal benefits should be relatively low. If instead, workers are liquidity-constrained, and consume primarily "hand to mouth" from current income, then benefits should be relatively higher. ...
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