Optimal unemployment insurance and international risk sharing

If a group of countries were to introduce a common unemployment insurance system, what should it look like? Using a two-country business cycle model with incomplete financial markets and frictional labor markets, we show that the optimal replacement rate becomes more countercyclical relative to a closed economy, due to the planner’s desire for international risk sharing. Moreover, it is feasible to channel cross-country transfers through the unemployment insurance system without affecting unemployment levels. When we calibrate our model to Eurozone data, optimal transfers are sizable and stabilize consumption mainly in the periphery countries, while optimal replacement rates are countercyclical overall.