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Unemployment Insurance Eligibility, Moral Hazardand Equilibrium Unemployment (No. E2010001)


Min Zhang *
Shanghai University of Finance and Economics
June, 2010

Abstract:This paper shows that the Mortensen-Pissarides search and matching model can be successfully parameterized to generate observed large cyclical fluctuations in unemployment and modest responses of unemployment to changes in unemployment insurance (UI) benefits. The key features behind this success are the consideration of the eligibility for UI benefits and the heterogeneity of workers. With the linear utilities commonly assumed in the Mortensen-Pissarides model, a fully rated UI system designed to prevent moral hazard has no effect on unemployment. However, the UI system in the United States is neither fully rated nor able to prevent workers with low productivity from quitting their jobs or rejecting employment offers to collect benefits. As a result, an increase in UI generosity has a positive, but realistically small, effect on unemployment. This paper answers the Costain and Reiter (2008) criticism to the Hagedorn and Manovskii (2008) strategy of adopting a high value of non-market activities to generate realistic business cycles with the Mortensen-Pissarides model.
Keywords: Search, Matching, Moral Hazard, UI Entitlement, Equilibrium Unemployment, Labor Markets.

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* This paper is part of my dissertation. It has been written under the supervision of Professor Miquel Faig, whom I thank for his generosity and encouragement. I also thank Shouyong Shi, Michael Reiter, Andres Erosa, Angelo Melino, Xiaodong Zhu, Diego Restuccia, Gueorgui Kambourov, Margarida Duarte and Michelle Alexopoulos for very useful comments. All errors are mine.