Abstract
When it is costly for individuals to save or to borrow, unemployment insurance (UI) provides an alternative source of liquidity that smooths consumption over time and leads individuals to spend longer unemployed searching for a suitable job. We show in a tractable life-cycle model how the optimal unemployment replacement ratio and the fall in consumption on job loss depend on the cost of self-insurance and the cost of borrowing. This implies that the value of UI depends on age at job loss, consumption needs (such as the presence of children), discount rates, the return on saving, access to credit and the presence of other social insurance programmes. Optimal replacement rates vary substantially with plausible variation in these factors (from less than 20 percent to almost 60 percent).
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Alan, S., & Browning, M. (2010). Estimating intertemporal allocation parameters using synthetic residual estimation. Review of Economic Studies, 77(4), 1231–1261.
Attanasio, O., Banks, J., Meghir, C., & Weber, G. (1999). Humps and bumps in consumption. Journal of Business & Economic Statistics, 17(1), 22–35.
Attanasio, O., & Brugiavini, A. (2003). Social security and household savings. The Quarterly Journal of Economics, 118(3), 1075–1120.
Attanasio, O., & Rohwedder, S. (2004). Pension wealth and household saving: Evidence from pension reforms in the U.K. The American Economic Review, 93(5), 1499–1521.
Bailey, M. (1978). Some aspects of optimal unemployment insurance. Journal of Public Economics, 10(3), 379–402.
Bloemen, H. G., & Stancanelli, E. G. F. (2005). Financial wealth, consumption smoothing, and income shocks arising from job loss. Economica, 72, 431–452.
Browning, M., & Crossley, T. F. (2001). Unemployment benefit levels and consumption changes. Journal of Public Economics, 80(1), 1–23.
Carroll, C. (1997). Buffer stock saving and the life cycle/permanent income hypothesis. The Quarterly Journal of Economics, 107(1), 1–56.
Chetty, R. (2006). A general formula for the optimal level of social insurance. Journal of Public Economics, 90, 1879–1901.
Chetty, R. (2008). Moral hazard vs. liquidity and optimal unemployment insurance. Journal of Political Economy, 116(2), 173–234.
Costain, J. (1999). Unemployment insurance with endogenous search intensity and precautionary savings. Draft, Universitat Pompeu Fabra.
Crossley, T., & Low, H. (2011). Job loss, credit constrains and consumption growth (Mimeo). University of Cambridge.
Deaton, A. (1991). Savings and liquidity constraints. Econometrica, 59, 1221–1248.
Diamond, P., & Mirrlees, J. A. (1979). A model of social insurance with variable retirement. Journal of Public Economics, 10, 295–336.
Dynan, K. E., Skinner, J., & Zeldes, S. P. (2002). The importance of bequests and life-cycle saving in capital accumulation: A new answer. American Economic Review, Papers and Proceedings, 92(2), 274–278.
Dynarski, S., & Gruber, J. (1997). Can families smooth variable earnings? Brookings Papers on Economics Activity, 1997(1), 229–303.
Engen, E. M., & Gruber, J. (2001). Unemployment insurance and precautionary savings. Journal of Monetary Economics, 47(3), 545–579.
Feldstein, M., & Altman, D. (1998). Unemployment insurance savings accounts (NBER Working Paper 6860).
Gruber, J. (1997). The consumption smoothing benefit of unemployment insurance. The American Economic Review, 87(1), 192–205.
Gruber, J. (2001). The wealth of the unemployed. Industrial & Labor Relations Review, 55(1), 79–94.
Hansen, G. D., & Imrohoroglu, A. (1992). The role of unemployment insurance in an economy with liquidity constraints and moral hazard. Journal of Political Economy, 100(1), 118–142.
Jappelli, T. (1990). Who is credit constrained in the U.S. economy? The Quarterly Journal of Economics, 105(1), 219–234.
Lentz, R. (2009). Optimal unemployment insurance in an estimated job search model with savings. Review of Economic Dynamics, 12(1), 37–57.
Meyer, B. (1990). Unemployment insurance and unemployment spells. Econometrika, 58, 757–782.
Mortensen, D. (1986). Job search and labor market analysis. In O. Ashenfeller & R. Layard (Eds.), Handbook of labor economics. Amsterdam: Elsevier Science.
Rendon, S. (2006). Job search and asset accumulation under borrowing constraints. International Economic Review, 47, 233–263.
Samwick, A. A. (1998). Discount rate heterogeneity and social security reform. Journal of Development Economics, 57, 117–146.
Sullivan, J. X. (2008). Borrowing during unemployment: Unsecured debt as a safety net. The Journal of Human Resources, 43(2), 383–412.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Crossley, T.F., Low, H. Borrowing constraints, the cost of precautionary saving and unemployment insurance. Int Tax Public Finance 18, 658–687 (2011). https://doi.org/10.1007/s10797-011-9172-1
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10797-011-9172-1