Unemployment insurance in a sticky-price model with worker moral hazard

Abstract

This paper studies the role of unemployment insurance in a sticky-price model that features an efficiency-wage view of the labor market based on unobservable effort. The risk-sharing mechanism central to the model permits, but does not force, agents to be fully insured. Structural parameters are estimated using a maximum-likelihood procedure on US data. Formal hypothesis tests reveal that the data favor a model in which agents only partially insure each other against employment risk. The results also show that limited risk sharing helps the model capture many salient properties of the business cycle that a restricted version with full insurance fails to explain.

Unemployment, Partial Insurance, and the Multiplier Effects of Government Spending

“…These similarities emerge because partial insurance, through its influence on the wage-setting process, actually bolsters the amount of endogenous price rigidity in the model. So even though the frequency of price changes is the same, the magnitude of those changes are smaller under partial insurance (e.g., Givens 2008;Givens, 2011). And like increases in the exogenous length of price fixity, this works to moderate the impact of spending shocks on inflation (see also Figure 8).…”

Unemployment, Partial Insurance, and the Multiplier Effects of Government Spending

“…As in Givens (2011), insurance premiums take the form $$F_t \equiv \sigma (1-N_t)hw_t$$, where $$\sigma \in [0,1]$$ determines the replacement rate. Notice here that $$\sigma$$ is exogenous by design.…”

“…That is because partial insurance, through its influence on the wage‐setting process, actually bolsters the amount of endogenous price rigidity in the model. So even though the frequency of price changes is the same, the magnitude of those changes are much smaller (e.g., Givens, 2008, 2011). And like increases in exogenous rigidity, this works to moderate the impact of spending shocks on inflation (see also Figure 8).…”