Labor market cycles, unemployment insurance eligibility, and moral hazard

If entitlement to UI benefits must be earned with employment, generous UI is an additional benefit to working, so, by itself, it promotes job creation. If individuals are risk neutral, then there is a UI contribution scheme that eliminates any effect of UI on employment decisions. As with Ricardian Equivalence, this result should be useful to pinpoint the effects of UI to violations of its premises. Our baseline simulation shows that if the neutral contribution scheme derived in this paper were to be implemented, the average unemployment rate in the United States would fall from 5.7 to 4.7 percent. Also, the results show that with endogenous UI eligibility, one can simultaneously generate realistic productivity driven cycles and realistic responses of unemployment to changes in UI benefits.

► We model endogenous eligibility to unemployment benefits in a standard matching model. ► With risk neutrality and a proper contribution scheme unemployment in surance is irrelevant. ► Unemployment in the United States would drop significantly with this neutral scheme. ► In the model, unemployment responds strongly to productivity shocks and weakly to benefit changes.