Unemployment insurance with limited commitment wage contracts and savings

  • 1 IRES, Université Catholique de Louvain, Collège L. H. Dupriez, 3 Place Montesquieu, 1348 Louvain la Neuve, Belgium
Rigas Oikonomou
  • Corresponding author
  • IRES, Université Catholique de Louvain, Collège L. H. Dupriez, 3 Place Montesquieu, 1348 Louvain la Neuve, Belgium
  • Email
  • Search for other articles:
  • degruyter.comGoogle Scholar


I present a model of optimal contracts between firms and workers, under limited commitment and with worker savings. In the model, firms provide insurance against unemployment through targeting a frontloaded path of wages which encourages wealth accumulation. I provide analytical results characterising the wage and savings schedules and the path of consumption during employment and unemployment. I then consider how unemployment benefits affect risk sharing through private markets. I find that benefits should be frontloaded; the government has the incentive to drive the allocation to the point where the firm’s participation constraint binds. At this point wages are equal to productivity in every period, wealth exceeds the buffer stock level, and consumption and savings drop over time. The drop in the level of consumption during unemployment is mitigated. Finally, I compare the optimal contract model to the standard heterogeneous agent model whereby wealth is utilized for self-insurance purposes. I show that the two models are equivalent under the optimal UI policy.

    • Supplementary material
  • Aiyagari, R 1994. “Uninsured Idiosyncratic Risk and Aggregate Saving.” Quarterly Journal of Economics 109 (3): 659–684.

  • Attanasio, O., and J. Rios Rull. 2000. “Consumption Smoothing in Island Economies: Can Public Insurance Reduce Welfare?” European Economic Review 44 (7): 1225–1258.

  • Chetty, R 2008. “Moral Hazard vs Liquidity in Optimal Unemployment Insurance.” Journal of Political Economy 116 (2): 173–234.

  • Deaton, A 1991. “Saving and Liquidity Constraints.” Econometrica 59 (5): 1221–1248.

  • Gruber, J 1997. “The Consumption Smoothing Benefits of Unemployment Insurance.” American Economic Review 87 (1): 192–205.

  • Hansen, G., and A. Imhrohoroglu. 1992. “The Role of Unemployment Insurance in an Economy with Liquidity Constraints and Moral Hazard.” Journal of Political Economy 100 (1): 118–142.

  • Huggett, M 1993. “The Risk Free Rate in Heterogeneous Agents Incomplete Insurance Economies.” Journal of Economic Dynamics and Control 17: 953–969.

  • Karaivanov, A., and F. Martin. 2015. “Dynamic Optimal Insurance and Lack of Commitment.” Review of Economic Dynamics 18 (2): 287–305.

  • Kocherlakota, N 1996. “Implications of Efficient Risk Sharing Without Commitment.” Review of Economic Studies 63 (4): 595–609.

  • Krusell, P., T. Mukoyama, R. Rogerson, and A. Sahin. 2010. “Labour Market Matching with Precautionary Savings and Aggregate Fluctuations.” Review of Economic Studies 77 (4): 1477–1507.

  • Ligon, E., J. Thomas, and T. Worrall. 2000. “Mutual Insurance, Individual Savings and Limited Commitment.” Review of Economic Dynamics 3 (2): 216–246.

  • Ljungqvist, L., and T. Sargent. 2000. Recursive Macroeconomic Theory., 2nd ed. Cambridge, MA: MIT Press.

  • Marcet, A., and R. Marimon. 2002. “Recursive Contracts.” mimeo Universitat Autonoma, Barcelona.

  • Nakajima, M 2012. “A Quantitative Analysis of Unemployment Benefits Extensions.” Journal of Monetary Economics 59 (7): 686–702.

  • Pissarides, C 2010. “Why Do Firms Offer Employment Protection.” Economica 77 (308): 613–636.

  • Rudanko, L 2009. “Labor Market Dynamics Under Long Term Wage Contracting.” Journal of Monetary Economics 56 (2): 170–183.

  • Rudanko, L 2011. “Aggregate and Idiosyncratic Risk in a Frictional Labor Market.” American Economic Review 101 (6): 2823–2843.

  • Thomas, J., and T. Worrall. 1988. “Self-Enforcing Wage Contracts.” Review of Economic Studies 55 (4): 541–554.

  • Thomas, J., and T. Worrall. 2007. “Unemployment Insurance Under Moral Hazard and Limited Commitment: Public Versus Private Provision.” Journal of Public Economic Theory 9 (1): 151–181.

  • Wang, C., and S. Williamson. 2002. “Moral Hazard, Optimal Unemployment Insurance and Experience Rating.” Journal of Monetary Economics 49 (7): 1337–1371.

  • Voena, A 2015. “Yours, Mine and Ours: D Divorce Laws Affect the Intertemporal Behavior of Married Couples.” American Economic Review 105 (8): 2295–2332.

  • Young, E 2004. “Unemployment Insurance with Capital Accumulation.” Journal of Monetary Economics 51 (8): 1683–1710.

Purchase article
Get instant unlimited access to the article.
Log in
Already have access? Please log in.

Log in with your institution

Journal + Issues

The B.E. Journal of Macroeconomics publishes significant research and scholarship in theoretical and applied macroeconomics. The range of topics includes business cycle research, economic growth, and monetary economics, as well as topics drawn from the substantial areas of overlap between macroeconomics and international economics, labor economics, finance, development economics, political economy, public economics, econometric theory.