Question

Consumption Smoothing and Crowd Out

(a) Suppose we were to find that giving individuals an additional dollar of social insurance has no effect on their consumption drop when faced with an unemployment shock. What does this imply about the level of crowd out? Explain (1-2 sentences)

(b) In the standard framework, what would that mean for the welfare gain from providing individuals with more generous social insurance? Explain, with reference to the optimal social insurance formula from class.

(c) Explain briefly the empirical strategy Gruber (1997) uses to estimate crowd out and what he finds (3-4 sentences)

Answer 1

a. This states that the level of crowding out is full as the drop in consumption due to unemployment shock cannot be prevented even by the social insurance benefit,

b. This states that the welfare gain is low from providing individuals with more generous social insurance as the social insurance cannot prevent fall in the consumption because of unemployment shock. Thus, welfare gains declines.

c. He states that those who receive unemployment benefits experienced little change in consumption during and after a period of unemployment.