Professor John Hassler, IIES, Stockholm University.

The focus in this part of the course is imperfect information. A basic assumption is that individual effort is unobservable for a planner who for some reason cares about the utility of the individual. We will cover two problems such an unobservability may create. The first is a moral hazard problem arising when the planner provides unemployment insurance. The government can observe the employment status of the individual but not how much search effort he exercise. The government wants to maximize the utility of the individuals but face the moral hazard problem that with too generous benefits, the search activity will be too low. A benchmark in the discussion will be the now classic result by Shavell& Weiss and Hopenhayn&Nicolini that if individuals have no hidden access to capital markets, unemployment benefits should decline over the unemployment spell. We will then discuss how sensitive this result is to alternative assumptions about, e.g., access to capital markets.

The second problem we will cover is when the planner wants to redistribute from high ability to low ability individuals. We can think of this as redistribution in order to maximize some aggregate welfare function but provided there is some stochastic development in ability over time, we can also think of ex-post redistribution as insurance. We will assume that the planner can observe income but neither ability nor effort. The problem is then that people can lie about there ability. The static analysis of this problem starts with the classic Mirrlees model. We will study recent results in an emerging literature called the “New Dynamic Public Finance”.


1 Introductory graduate macroeconomics.

2 Dynamic optimization – knowledge of standard dynamic programming.



I will follow fairly my fairly extensive notes during the course. It is likely to be useful to print and bring the notes to class. Notes will be posted here.

Starred articles below are recommended to everyone.

Optimal unemployment insurance (UI)

1. The Dynamic approach with observable savings

Baily, Martin Neil, (1978) “Some Aspects of Optimal Unemployment Insurance”, Journal of Public Economics, December 1978, pp. 379-402

*Ljungqvist, Lars and Thomas J. Sargent, “Recursive Macroeconomic Theory”, Chapter 21, Second Edition, MIT Press

*Shavell, S. and Weiss, L.: 1979, “The optimal payment of unemployment insurance benefits over time”, Journal of Political Economy 87(6), 1347–1362.

*Hopenhayn, H. A. and Nicolini, J. P.: 1997, “Optimal unemployment insurance”, Journal of Political Economy 105(2), 412–438.

Hopenhayn, H. A. and Nicolini, J.P., 2005, “Optimal Unemployment Insurance and Employment History”, mimeo.

Rendahl, Pontus, 2007, “Asset Based Unemployment Insurance”, mimeo, EUI.

Pavoni, Nicola and Gianluca Violante, 2007, “Optimal Welfare-to-Work Programs”, Review of Economic Studies,74, 283–318

2. The Dynamic approach with unobservable savings

*Shimer, Robert and Ivan Werning, 2005, “Liquidity and insurance for the unemployed” NBER Working Paper 11689.

*Hassler, John and J.V. Rodriguez Mora, 2008, “Unemployment Insurance Design: how to induce moving and retraining” , European Economic Review, 52: 5, July 2008, pp. 757-79

New Public Finance – the Mirrlees approach

1. Static models

*Mirrlees, James A. 1971. “An Exploration in the Theory of Optimum Income Taxation”, Review of Economic Studies 38(2): 175–208

*Stigliz, Joseph, 1987, “Pareto Efficient and Optimal Taxation and the New New Welfare Economics”, NBER Working Paper #2189

Emmanuel Saez (2001), “Using Elasticities to Derive Optimal Income Tax Rates”, Review of Economic Studies 68 (1), 205–229.

2. Dynamic models

 Golosov, Mikhail, Aleh Tsyvinski and Iván Werning, “New Dynamic Public Finance: A User’s Guide”, mimeo Harvard University

*Golosov, Mikhail, and Aleh Tsyvinski, (2006), “Designing Optimal Disability Insurance”, Journal of Political Economy, 114:2.

Albanesi, Stefania; Sleet, Christopher, “Dynamic Optimal Taxation with Private Information”, Review of Economic Studies”, January 2006, v. 73, iss. 1, pp. 1-30

Golosov, M., N. Kocherlakota, and A. Tsyvinski (2003), “Optimal Indirect and Capital Taxation”. Review of Economic Studies 70, 569-588

Kocherlakota, Narayana R. 2005, “Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation”, Econometrica 73(5): 1587–162

Townsend, Robert , (1982), “Optimal Multiperiod Contracts and the Gain from Enduring Relationships under Private Information,” The Journal of Political Economy, Vol. 90, No. 6

Kapička, Marek, 2006, "The Dynamics of Optimal Taxation when Human Capital is Endogenous”, mimeo, UCSB.

3. Time Consistency

*Roberts, Kevin, (1984), “Theoretical Limits to Redistribution”, Review of Economic Studies, 51:177-95.

Acemogly, Daron, Mikhail Golosov, and Aleh Tsyvinski, (2006), “Markets versus Governments: Political Economy of Mechanisms”, mimeo, MIT.

Kapička, Marek, 2005, “Efficient Allocations in Dynamic Private Information Economies with Persistent Shocks: A First Order Approach”, mimeo, UCSB.