Consumption Commitments and Moral Hazard: Theory and Evidence from Older Workers

Abstract: 
Prior research has shown that unemployment insurance (UI) reduces labor supply among younger workers, but it does not seem to do so for older workers. A potential explanation for the difference may be that the older population (age 40-60) faces consumption commitments in the form of goods involving transaction costs, so they are constrained from changing their consumption patterns frequently. The objective of this project is to investigate the effects of consumption commitments on labor supply and welfare. Our hypothesis is that older workers with consumption commitments respond less to policy changes in unemployment insurance than younger workers. In other words, moral hazard induced by unemployment insurance is modest for older workers. As a result, a deviation from optimal consumption caused by adjustment cost can reduce older workers’ welfare. For this reason, social welfare gains are potentially feasible by redistributing unemployment benefits from younger workers to older workers to maintain consumption commitments without sacrificing too much non-commitment consumption. We will use the expiration of unemployment insurance extension (EUC08) in December 2013 and data from the CPS and SIPP to examine whether older and younger workers responded differentially.
Funded By: 
Boettner
Award Dates: 
July 1, 2015 - June 30, 2016