The Ex Ante Optimal Unemployment Insurance

The optimal unemployment insurance (UI) literature initiated by the seminal work of Baily (1978) focuses on unemployed workers’ moral hazard in job search conditional on “unemployment that has already occurred” – the ex post approach. In contrast, this study considers the optimal UI “before unemployment occurs” – the ex ante approach – by looking at moral hazard in work efforts of employed workers caused by generous benefits and the resulting firms’ endogenous employment adjustment. A notable advantage of taking this ex ante approach is that we can study the interaction between individuals and firms in response to UI benefit changes in a general equilibrium framework. New findings include: (i) labor supply elasticity is a central determinant of the optimal benefit level, more important than the risk aversion parameter; (ii) the optimal benefit level is also sensitive to the size of existing public expenditures; and (iii) the optimal level is lower than those in existing studies taking the ex post approach