Reservation wages and unemployment insurance

this version is optimized for horizontal screen viewing click here to download the vertical version suitable for printing ∗We are grateful to seminar participants at Berkeley, Harvard, and MIT and for detailed comments from Raj Chetty, Lawrence Katz, and two anonymous referees. Shimer’s research is supported by a grant from the National Science Foundation. Werning is grateful for the hospitality of the Federal Reserve Bank of Minneapolis and Harvard University. Back 1 This paper argues that a risk-averse worker’s after-tax reservation wage encodes all the relevant information about her welfare. This insight leads to a novel test for the optimality of unemployment insurance based on the responsiveness of reservation wages to unemployment benefits. Some existing estimates imply significant gains to raising the current level of unemployment benefits in the United States, but highlight the need for more research on the determinants of reservation wages. Our approach complements those based on Baily’s (1978) test. Section 1: Introduction Back 2 1