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Tuesday, December 22, 2009

"Standard Models Predict That We Should Have No Safety Net"

It seems that Harvard's Raj Chetty was a motivated student:

Chetty finished his bachelor’s degree, wrote a prize-winning thesis, and completed the course work for a doctorate in economics — all in three years. ...

Sounds like he's some kind of human calculator:

Chetty, who just turned 30, is looking for ways to make ... mathematical economic theory more descriptive of the tangle of economics in the real world. “People are not human calculators,” he said...

OK, maybe not. His goal is to "refine the economic models behind public policy ... to ... save money and align government programs more closely with everyday life." An example is his work on government safety nets for the unemployed:

Chetty’s 2003 Ph.D. dissertation..., called “Consumption, Commitments, and Risk Preferences,”... [studies] the optimal level of unemployment benefits. When someone is laid off, should the government provide high benefits? Traditional theory says no, since big benefits seemingly reduce the incentive to find a job. “Standard models predict that we should have no safety net,” said Chetty.
But in reality, higher benefits are more in line with actual needs, because most Americans have so much income tied up in fixed commitments, such as payments for houses, cars, and furniture. “There are a lot of things you can’t adjust in the short term,” he said.
So the traditional economic models that are used to determine unemployment benefits miss a simple fact: People have bills to pay. “You miss certain features of reality,” said Chetty, “when you’re trying to write down simple models of the world.”

Unfortunately, in reality, some bills for houses, cars, furniture, etc. may not get paid:

States' jobless funds are being drained in recession, by Peter Whoriskey, Washington Post: The recession's jobless toll is draining unemployment-compensation funds so fast that ... 25 states have run out of unemployment money and have borrowed $24 billion from the federal government to cover the gaps. By 2011, according to Department of Labor estimates, 40 state funds will have been emptied by the jobless tsunami. ...
State unemployment-compensation funds are separated from general budgets, so when there is a shortfall, only two primary solutions are typically considered -- either cut the benefit or raise the payroll tax. ...
The troubles the state programs face can be traced to a failure during the economic boom to properly prepare for a downturn, experts said.
Unemployment benefits are funded by the payroll tax on employers that is collected at a rate that is supposed to keep the funds solvent. Firms that fire lots of people are supposed to pay higher rates. ... But over the years, the drive to minimize state taxes on employers has reduced the funds to unsustainable levels.
"The benefits haven't grown -- that's not the problem," said Richard Hobbie, director of the National Association of State Workforce Agencies. Even so, he said, he expects to see unemployment checks reduced. A shortfall in a state unemployment fund, he said, "usually means cuts in eligibility or benefits." ...
Wayne Vroman, an expert in unemployment insurance at the Urban Institute, said that entering the recession, state programs were on average funded at only one-third the level they should have been, according to generally accepted funding guidelines.
"If you fund a program adequately, you don't need to come to these kinds of difficult decisions," he said. Before the recession, he said, the funding guidelines "were rarely honored." ...

We can add the inadequate funding of unemployment compensation programs to the ever growing list of things that the crisis has revealed need to be fixed.

    Posted by on Tuesday, December 22, 2009 at 12:12 AM in Economics, Social Insurance, Unemployment | Permalink  TrackBack (0)  Comments (43)


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