Aspects of optimal unemployment insurance: Search, leisure, savings and capital market imperfections

Abstract

Unemployment insurance is analysed in the optimal taxation framework. Benefits discourage search and thus raise unemployment. A perfect capital market model is developed and solved explicitly for a constant absolute risk aversion utility function. For ‘realistic’ parameter values low replacement rates (less than 50%) are optimal. If there is no lending or borrowing the optimal rates rise to about 75%. Alternative models also admit leisure as a good and the input to search; this reduces optimal replacement when the capital market is perfect. When it is nonexistent the optimal benefits depend on the value of leisure - rising as it falls. Alternatives to constant benefits conditional on continued unemployment are considered.