Joseph Stiglitz | National Bureau of Economic Research | August 2021

Imperfections in risk and capital markets imply that individuals who lose jobs suffer from imperfect smoothing of consumption across states and times. Compared to the first best, there will be too little search. Optimal unemployment programs, which balance the marginal benefit of consumption smoothing vs. the marginal cost of the insurance externality, increase welfare and may even increase GDP. Our analytical results suggest that welfare is higher if the unemployment benefits program includes income-contingent unemployment loans (ICL), where the amount repaid depends on the individual’s future income. Such loans can be financed by a risk premium imposed on the unemployed who avail themselves of the loans, and partially substitute for unemployment insurance (UI) benefits. Optimal unemployment benefits programs (UB) with ICL do a better job of smoothing consumption across states and time, and in particular total benefits when unemployed increase. We analyze how changes in key parameters, such as the degree of risk aversion and the nature of post-employment work, affect the design of the optimal UB program and the magnitude of the incremental benefits from including income-contingent loans.

Why is that? And what can be done about it? These are the questions that Nikhar Gaikwad, Assistant Professor of Political Science at Columbia University, and Gareth Nellis, Assistant Professor of Political Science at the University of California, San Diego, have sought to examine in much of their research.

Originally published by National Bureau of Economic Research. Read the full article here.