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).
Authors
Research Fellow University of Oxford
Hamish is the James Meade Professor of Economics at the University of Oxford, a Professorial Fellow of Nuffield College and a Research Fellow at IFS.
Research Fellow University of Michigan
Tom is a Research Fellow at IFS, a Research Professor for the Institute for Social Research at the University of Michigan.
Journal article details
- Publisher
- Springer Verlag
- ISSN
- 0927-5940
- JEL
- J65; H53; D91
- Issue
- May 2011
Suggested citation
Crossley, T and Low, H. (2011). 'Borrowing constraints, the cost of precautionary saving and unemployment insurance' (2011)
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