Unintended consequences of unemployment insurance benefits: the role of banks

Focus

Unemployment is one of the most important economic risks faced by individuals. For this reason, governments provide unemployment insurance (UI) to their citizens by providing a certain level of income for a limited time during the spell of unemployment. At the macro level, UI is regarded as an efficient fiscal policy tool that smooths business cycles. However, to the extent that UI lowers individual and macroeconomic risks, it should reduce precautionary savings by households, and hence bank deposits. As deposits are the main stable source of funding for banks, more generous UI may also erode bank lending.

Contribution

Discussions about the costs and benefits of UI policies have focused mainly on enhanced consumer welfare or the distorting effects on job search and job creation. Our findings suggest that UI policies could also have large negative macroeconomic implications via their effects on bank funding and lending.

Findings

We show by using disaggregated US data that in response to a one standard deviation increase in state UI benefits, a county's total deposits declines by 2.2%. This fall in deposits leads banks to squeeze their commercial lending, which in turn lowers corporate investment.

Abstract

Many countries provide unemployment insurance (UI) to reduce individuals' income risk and to moderate fluctuations in the economy. However, to the extent that these policies are successful, they would be expected to reduce precautionary savings and hence bank deposits--households' main saving instrument. In this paper, we study this reduced incentive to save and uncover a novel distortionary mechanism through which UI policies affect the economy. In particular, we show that, when UI benefits become more generous, bank deposits fall. Since deposits are the main stable funding source for banks, this fall in deposits squeezes bank commercial lending, which in turn reduces corporate investment.

JEL classification: D14, G21, J65

Keywords: unemployment insurance, precautionary savings, bank deposits