Unemployment benefits can address the failures of credit markets by enabling unemployed people to spend more time searching for a new job – even in countries like Norway, which have an equitable wealth distribution and a generous welfare state. That is the central conclusion of research by Christoph Basten, Andreas Fagereng and Kjetil Telle, published in the May 2014 issue of the Economic Journal.

Their study finds that less well-off people in Norway who lost their job but were entitled to one-off severance payments were able to spend more time in unemployment looking for the most suitable job. Such longer search duration has the social value of enabling the unemployed to find a job that better matches their skills, hence allowing them to earn a higher salary and pay higher taxes. The authors comment:

''Our findings show that unemployment benefits can be useful not only on the grounds of equity concerns, but also with a view to economic efficiency.

''Even more efficient may be the granting of well-designed loans to the unemployed, as these could relieve liquidity concerns without causing any moral hazard.''

Over decades, economists have interpreted prolonged unemployment spells among those who receive unemployment benefits as an expression of ''moral hazard'': the unemployed were presumed to exert only limited effort in their job search since someone else was paying for their cost of living during unemployment.

This interpretation was first questioned by David Card, Raj Chetty and Andrea Weber, who argued that unemployment benefits (or any social insurance payments) can affect behaviour in the labour market through two channels:

• First, there may be a substitution or price effect: by reducing the cost of staying unemployed relative to the cost of starting a new job, benefits can make it relatively more attractive to stay unemployed.

• Second, however, the benefits may have an income effect: they may enable the unemployed to search longer, where this is optimal, but would not otherwise be possible since the unemployed may have insufficient savings and may find it difficult to obtain the necessary credit through the banking system.

Card and his colleagues showed that unemployment in Austria was prolonged by severance payments that were paid on layoff, rather than for each day spent in unemployment. These payments could by definition not have a price effect on the duration of unemployment, and so the findings showed the existence of an income effect for the Austrian unemployed.

Put differently, the Austrian unemployed were ''liquidity-constrained'' and banks'' failure to lend to them could be considered a market failure. Severance payments or unemployment benefits could then amend the market failure.

But two questions remained: first, it was unclear whether the effect of severance pay on unemployment durations really reflected liquidity constraints. Second, since Card and his colleagues argued that the Austrian system of unemployment benefits was very much like the US system, with a maximum benefit duration of six months, one had to wonder whether such liquidity constraints would also be relevant in other OECD economies, the majority of which have more generous social insurance systems.

The new study addresses both concerns. First, the authors show that one-off severance payments prolong unemployment duration in Norway, an economy with one of the most equitable of wealth distributions and one of the most generous welfare states of all OECD economies.

To show the causality between severance pay and unemployment duration (when severance pay is often tied to factors like age, which also has a direct effect on unemployment duration), they use the fact that workers who were laid off when aged 50 or above were entitled to a substantial severance payment, while those laid off just before age 50 were not.

Using the technique of ''regression discontinuity design'', the authors compare unemployment durations between job seekers just above the age 50 threshold and job seekers just below that threshold. Those two groups are shown to be comparable in all respects other than their eligibility for severance pay. The results suggest that liquidity constraints are likely to be a relevant phenomenon in many other OECD economies than just Austria.

Furthermore, by use of Norwegian tax data on private wealth, the authors show that the effect of severance pay on unemployment duration only exists for those with below-median wealth. This corroborates the interpretation of the effect as evidence of liquidity constraints.

 ''Cash-on-hand and the Duration of Job Search: Quasi-experimental evidence from Norway'' by Christoph Basten, Andreas Fagereng and Kjetil Telle is published in the Conference issue of the Economic Journal. Christoph Basten is at ETH Zurich. Andreas Fagereng and Kjetil Telle are at Statistics Norway.