Temptation, Self-Control, and the Design of Optimal Unemployment Insurance

Zoe Leiyu Xie and Pei Cheng Yu

No 11265, Policy Research Working Paper Series from The World Bank

Abstract: his paper studies how the unemployment insurance system should be designed when considering costly self-control. The standard optimal unemployment insurance with dynamic moral hazard features declining benefits over the unemployment spell, without a lower bound on consumption (“immiseration”). As documented in the empirical literature, unemployed workers may be tempted to undervalue the future benefits of job search. The paper models this behavioral bias using costly self-control—a utility cost incurred when a worker’s job search choice deviates from the choice that maximizes current period utility and disregards future utility. Compared with the standard setup with moral hazard alone and without behavioral bias, the optimal system features lower benefit levels, a less rapid decline in benefits over the unemployment spell, a lower bound on consumption for the unemployed, and a one-time reward when a worker returns to work. The findings suggest that food assistance benefits and a back-to-work bonus in many U.S. states are broadly in line with such an optimal unemployment system.

Date: 2025-12-01
New Economics Papers: this item is included in nep-dge, nep-lab and nep-upt
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