When Might Unemployment Insurance Matter?

Unemployment insurance is more valuable when self-insurance is more diffcult. Self-insurance is more viable when the cost of borrowing and the cost of saving are low. The cost of savings depends on the timing of income and the timing of needs, as well as private and market discount rates. Heterogeneity in any of these factors translates into heterogeneity in the cost of saving and thus in the value of unemployment insurance. We develop a life-cycle model to illustrate these connections. We then provide empirical evidence on the extent of credit constraints and heterogeneity in the cost of saving among job losers. Among job losers, 25% do not have access to credit markets. Liquid assets that can be used to buffer employment shocks are lower for households with children (high needs). Among older households, those with illiquid pension wealth have less liquid wealth.

Unexploited Connections Between Intra- and Inter-temporal Allocation

This paper shows that a power utility specification of preferences over total expenditure (ie. CRRA preferences) implies that intratemporal demands are in the PIGL/PIGLOG class. This class generates (at most) rank two demand systems and we can test the validity of power utility on cross-section data. Further, if we maintain the assumption of power utility, and within period preferences are not homothetic, then the intertemporal preference parameter is identified by the curvature of Engel curves. Under the power utility assumption, neither Euler equation estimation nor structural consumption function estimation is necessary to identify the power parameter. In our empirical work, we use demand data to estimate the power utility parameter and to test the assumption of the power utility representation. We .nd estimates of the power parameter larger than obtained from Euler equation estimation, but we reject the power specification of within period utility

Estimating Euler equations

In this paper we consider conditions under which the estimation of a log-linearized Euler equation for consumption yields consistent estimates of preference parameters. When utility is isoelastic and a sample covering a long time period is available, consistent estimates are obtained from the log-linearized Euler equation when the innovations to the conditional variance of consumption growth are uncorrelated with the instruments typically used in estimation. We perform a Montecarlo experiment, consisting in solving and simulating a simple life cycle model under uncertainty, and show that in most situations, the estimates obtained from the log-linearized equation are not systematically biased. This is true even when we introduce heteroscedasticity in the process generating income. The only exception is when discount rates are very high (e.g. 47% per year). This problem arises because consumers are nearly always close to the maximum borrowing limit: the estimation bias is unrelated to the linearization and estimates using nonlinear GMM are as bad. Across all our situations, estimation using a log-linearized Euler equation does better than nonlinear GMM despite the absence of measurement error. Finally, we plot life cycle profiles for the variance of consumption growth, which, except when the discount factor is very high, is remarkably flat. This implies that claims that demographic variables in log- linearized Euler equations capture changes in the variance of consumption growth are unwarranted.

Disability risk, disability insurance and life cycle behavior

The Disability Insurance (DI) program in the US is a large social insurance program that offers income replacement benefits to people with work limiting disabilities. The proportion of DI claimants in the US is now almost 5% of the working-age population and the cost is three times that of unemployment insurance. The key questions in thinking about the size and growth of the DI program are whether program claimants are genuinely unable to work, and how valuable is the insurance provided. This paper has three aims: We provide a framework for weighing up the insurance value of disability benefi…ts against the incentive cost of inducing healthy individuals to stop work at different points of their life-cycle. We estimate the risks to health that may lead to work-limiting disabilities and the risk to wages that may lead to individuals choosing not to work. We also estimate the extent of false awards made through the DI program alongside the proportion of awards to those in genuine need. We use our model and estimates to characterize the economic effects of the disability insurance and to consider how policy reforms would affect behaviour and standard measures of household welfare. We differentiate disability status by its severity, and show that a severe disability shock leads to a decline in wages of 40%, as well as a substantial rise in the fixed cost of going to work. In terms of the effectiveness of the DI program, we estimate high levels of rejections of genuine applicants. In our counterfactual simulations, this means that household welfare increases as the program becomes less strict, despite the worsening incentives for false applications that this implies. On the other hand, incentives for false applications are reduced by reducing generosity and increasing reassessments, and these policies increase household welfare, despite the worse insurance implied.Disability, social security, savings behavior, wage risk

Is the elasticity of intertemporal substitution constant?

This paper shows that a power utility specification of preferences over total expenditure (ie. CRRA preferences) implies that intratemporal demands are in the PIGL/PIGLOG class. This class generates (at most) rank two demand systems and we can test the validity of power utility on cross-section data. Further, if we maintain the assumption of power utility, and within period preferences are not homothetic, then the intertemporal preference parameter is identified by the curvature of Engel curves. Under the power utility assumption, neither Euler equation estimation nor structural consumption function estimation is necessary to identify the power parameter. In our empirical work, we use demand data to estimate the power utility parameter and to test the assumption of the power utility representation. We find estimates of the power parameter larger than obtained from Euler equation estimation, but we reject the power specification of within period utility.Elasticity of intertemporal substitution, Euler equation estimation, demand systems

Income risk and consumption inequality: a simulation study

This paper assesses the accuracy of decomposing income risk into permanent and transitory components using income and consumption data. We develop a specific approximation to the optimal consumption growth rule and use Monte Carlo evidence to show that this approximation can provide a robust method for decomposing income risk. The availability of asset data enables the use of a more accurate approximation allowing for partial self-insurance against permanent shocks. We show that the use of data on median asset holdings corrects much of the error in the simple approximation which assumes no self-insurance against permanent shocks.income risk, inequality, approximation methods, con-

The economics of a temporary VAT cut

1. The rate of VAT has been cut temporarily to 15%, with a return to 17.5% in place for the end of 2009. The government has predicted that this will increase consumer spending by about 0.5%. Much of the analysis of this tax cut has been critical of the policy and concluded that the government's estimates of the impact on spending are over-optimistic. The source of this criticism is a misunderstanding of the mechanism through which the tax cut will have an impact. In fact, we believe the government's estimates are overly-pessimistic. 2. There are two mechanisms through which the temporary VAT cut might affect spending: first, it will increase spending power, making households feel as if they have more income. This mechanism is likely to be small partly because the tax cut increases income only for one year, and so the increase in total lifetime resources is very small, and partly because the lost revenue will have to be paid back. 3. However, the second (often ignored) mechanism is likely to be much more important. This second mechanism is the effect that the tax cut will have through changing the price of goods bought in 2009 compared to 2010: the cost of goods bought in 2009 has fallen compared to goods bought in 2010 and this change in prices gives an incentive to bring forward consumer spending to this year, rather than waiting until next. 4. Economic evidence on households' willingness to move spending from one year into an earlier (or later) year suggests that a 1% fall in the price today will translate into a 1% increase in spending. Since roughly only half of goods purchased are subject to VAT, the cut in the rate by 2.5% is like a cut in prices today by 1.25% and we would expect this to boost spending by about 1.25% over what it would otherwise be. 5. Of course, this issue of what the spending would otherwise be is crucial: we will not now know what spending in 2009 would have been without the cut in VAT and even with the VAT cut, spending is likely to decline. Our point is simply that economic analysis shows that the cut in VAT will make the situation significantly less bad than it might otherwise have been. 6. A natural comparison to the fiscal stimulus of a cut in VAT is a monetary stimulus through a cut in the interest rate: both make the price of spending today low compared to next year - an interest rate cut makes saving less attractive than current spending, as does the cut in VAT. The 1.25% fall in prices due to the cut in VAT reduces the price of spending today by more than a 1% point cut in the interest rate. It is surprising that some commentators have labeled the former as "small", while the latter would typically be considered a large cut. 7. There is however a difference between cutting interest rates and cutting VAT: a cut in interest rates penalises savers, whose spending power falls, and rewards borrowers. By contrast, the cut in VAT increases the spending power of savers (as well as borrowers) and this seems a fairer way to stimulate the economy.

Wage Risk and Employment Risk over the Life Cycle

We specify a structural life-cycle model of consumption, labour supply and job mobility in an economy with search frictions that allows us to distinguish between different sources of risk and to estimate their effects. The sources of risk are shocks to productivity, job destruction, the process of job arrival when employed and unemployed and match level heterogeneity. Our model allows for four main social insurance programmes. In contrast to simpler models that attribute all income fluctuations to shocks, our framework allows us to disentangle the effects of the shocks from the responses to these shocks. Estimates of productivity risk, once we control for employment risk and for individual labour supply choices, are substantially lower than estimates that attribute all wage variation to productivity risk. Increases in productivity risk impose a considerable welfare loss on individuals and induce substantial precautionary saving. Increases in employment risk have large effects on output and, primarily through this channel, affect welfare. The welfare value of government programs such as food stamps which partially insure productivity risk is greater than the value of unemployment insurance which provides (partial) insurance against employment risk and no insurance against persistent shocks.uncertainty, life-cycle models, unemployment, precautionary savings

Unexploited Connections Between Intra- and Inter-temporal Allocation

This paper shows that a power utility specification of preferences over total expenditure (ie. CRRA preferences) implies that intratemporal demands are in the PIGL/PIGLOG class. This class generates (at most) rank two demand systems and we can test the validity of power utility on cross-section data. Further, if we maintain the assumption of power utility, and within period preferences are not homothetic, then the intertemporal preference parameter is identified by the curvature of Engel curves. Under the power utility assumption, neither Euler equation estimation nor structural consumption function estimation is necessary to identify the power parameter. In our empirical work, we use demand data to estimate the power utility parameter and to test the assumption of the power utility representation. We find estimates of the power parameter larger than obtained from Euler equation estimation, but we reject the power specification of within period utility.elasticity of intertemporal substitution, Euler equation estimation, demand systems

Decomposing Changes in Income Risk Using Consumption Data

We develop a new approach to the decomposition of income risk within a nonstationary model of intertemporal choice. The approach allows for changes in income risk over the life-cycle and with the business cycle. It requires only repeated cross-section data and can allow for mixtures of persistent and transitory components in the dynamic process for income. Evidence from a stochastic simulation of consumption choices in a nonstationarity environment is used to show the robustness of the method for decomposing income risk. The approach is used to investigate the changes in income risk in Britain across the inequality growth period from the late 1970s to the late 1990s. Peaks in the variance of permanent shocks are shown to occur in the middle of the 1980s and the early 1990s.income risk, consumption, nonstationarity, inequality