Reference-dependent job search: evidence from Hungary

We propose a model of job search with reference-dependent preferences, with loss aversionrelative to recent income (the reference point). In this model, newly unemployed individualssearch hard since consumption is below their reference point. Over time, though, they getused to lower income, and thus reduce their search effort. In anticipation of a benefit cuttheir search effort rises again, then declines once they get accustomed to the lower post-cutbenefit level. The model fits the typical pattern of exit from unemployment, even with nounobserved heterogeneity. To distinguish between this and other models, we use a uniquereform in the UI benefit path. In 2005, Hungary switched from a single-step UI system to atwo-step system, with overall generosity unchanged. The system generated increased hazardrates in anticipation of, and especially following, benefit cuts in ways the standard model hasa hard time explaining. We estimate a model with optimal consumption, endogenous searcheffort, and unobserved heterogeneity. The reference-dependent model fits the hazard ratessubstantially better than plausible versions of the standard model, including habit formation.Our estimates indicate a slow-adjusting reference point and substantial impatience, likelyreflectingpresent-bias.