Liquidity and Insurance for the Unemployed

   (265 K)

We study the optimal design of unemployment insurance for workers sampling job opportunities over time. We focus on the timing of benefits and the desirability of allowing workers to freely access a riskless asset. When workers have constant absolute risk aversion preferences, a very simple policy is optimal: a constant benefit during unemployment, a constant tax during employment, and free access to savings using the riskless asset. Away from this benchmark, for constant relative risk aversion preferences, the optimal policy involves nearly constant benefits and the welfare gains from more elaborate policies are minuscule. Our results highlight two distinct roles for policy toward the unemployed: ensuring workers have sufficient liquidity to smooth their consumption; and providing unemployment subsidies that serve as insurance against the uncertain duration of unemployment spells.

Published: Shimer, Robert and Ivan Werning. “Liquidity and Insurance for the Unemployed.” American Economic Review 98, 5 (2008): 1922–1942.

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This paper was revised on September 6, 2007

Acknowledgments

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