Does the Moral Hazard Cost of Unemployment Insurance Vary With the Local Unemployment Rate? Theory and Evidence

In this paper, we study both theoretically and empirically how optimal Unemployment Insurance (UI) bene…ts vary with local labor market conditions. Theoretically, we show in a search model that the adverse incentive e¤ect of UI varies with the current level of unemployment and we consider the policy implications using a "su¢ cient statistics" approach to welfare analysis. This analysis motivates our empirical strategy which tests whether the e¤ect of UI bene…ts on unemployment duration varies with the unemployment rate. Our preliminary …ndings indicate that moral hazard is signi…cantly lower when the local unemployment rate is relatively high. We use the empirical estimates to calibrate the optimal UI formula, and preliminary …ndings indicate that a 1 percentage point increase in the unemployment rate leads to a 20% increase in the optimal replacement rate. E-mail: [email protected]; [email protected]. This work is preliminary and incomplete. Please do not cite without the authors’permission. We would like to thank Jonathan Guryan for providing excellent comments. Notowidigdo gratefully acknowledges the National Institute of Aging (NIA grant number T32AG000186) for …nancial support.