Moral Hazard Vs. Liquidity And Optimal Unemployment Insurance
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. The author shows 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, the author finds 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.