Consumer Bankruptcy and Unemployment Insurance

We quantitatively evaluate the effects of UI on bankruptcy in an equilibrium model of labor market search and defaultable debt. First, we ask whether a standard unsecured credit model extended with labor market search and matching frictions can account for the negative correlation between UI caps and bankruptcy rates observed in the data. The model can account for this fact only if estimated with the employment rate among bankruptcy filers as a target. Not matching this employment rate underestimates the consumption smoothing benefits of UI cap increases, as the model assigns too much importance to unemployment shocks for driving default, and implies large welfare losses from increasing the cap rather than negligible gains. Second, with bankruptcy available, there are significant welfare gains from increasing the replacement rate above the calibrated value, but not in the absence of default.