Crowding Out or Crowding In? UI and Private Insurance

This paper explores the welfare consequences of unemployment insurance when private insurance markets are subject to enforcement frictions that limit debt accumulation, endogenously determining individual borrowing limits as a function of the length of unemployment. Reducing the replacement rate in the model initially increases borrowing, as the value of default declines significantly. As the replacement rate continues to fall, borrowing eventually is restricted, with zero borrowing sustainable at a zero replacement rate. In the neighborhood of the current US policy UI crowds out private insurance. The paper attributes only a small fraction of the changes caused by UI to endogenous debt limits.