Quantifying the psychological costs of unemployment: the role of permanent income

Abstract

Unemployment causes significant losses in the quality of life. In addition to reducing individual income, it also creates nonpecuniary and psychological costs. We quantify these nonpecuniary losses by using the life satisfaction approach. In contrast to previous studies, we apply Friedman's (1957) permanent income hypothesis by distinguishing between temporary and permanent effects of income changes. This allows us to account for intertemporal spillovers of income compensations. Our results show that the nonpecuniary costs of unemployment are only half as large compared to a standard estimation without this distinction. Nevertheless, the nonpecuniary costs of unemployment calculated with this modified quantification method are still about two times higher than its pecuniary costs. This confirms the high value of work for life satisfaction.