Optimal unemployment insurance in Turkey in the presence of moral hazard and liquidity constraints

Abstract

This study aims to analyze and improve the Unemployment Insurance Program adopted in Turkey. Such programs are praised highly in the world for providing relief to unemployed people. On the other hand, they are criticized for the adverse incentives they introduce to agents’ reemployment efforts. I address this issue by employing an incomplete markets equilibrium model. Agents are making endogenous employment decisions depending on the generosity of the insurance payments. The model is calibrated so that it would mimic Turkish economy in 2004-2008. For a 10% lower bound level for moral hazard, the results indicate, welfare can be increased by 0.15% by adopting an optimal unemployment insurance program. Next, I extend the model to a case where eligibility to unemployment benefits are stochastic. This extension allows the model to account for the fact that these benefits are paid only for a limited time. For a 10% moral hazard rate, the welfare gains from adopting an optimal program are reduced to 0.01%. However, both welfare results are sensitive to degree of moral hazard. Welfare gains get as high as 9.17% for higher levels of moral hazard.