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Optimal Unemployment Insurance over the Business Cycle

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  • Camille Landais
  • Pascal Michaillat
  • Emmanuel Saez

Abstract

This paper examines how optimal unemployment insurance (UI) responds to the state of the labor market. The theoretical framework is a matching model of the labor market with general production function, wage-setting mechanism, matching function, and preferences. We show that optimal UI is the sum of a conventional Baily-Chetty term, which captures the trade-off between insurance and job-search incentives, and a correction term, which is positive if UI brings labor market tightness closer to its efficient level. The state of the labor market determines whether tightness is inefficiently low or inefficiently high. The response of optimal UI to the state of the labor market therefore depends on the effect of UI on tightness. For instance, if the labor market is slack and tightness is inefficiently low, optimal UI is more generous than the Baily-Chetty level if UI raises tightness and less generous if UI lowers tightness. Depending on the production function and the wage-setting mechanism, UI could raise tightness, for example by alleviating the rat race for jobs, or lower tightness, for example by increasing wages through bargaining. To determine whether UI raises or lowers tightness in practice, we develop an empirical criterion. The criterion involves a comparison of the microelasticity and the macroelasticity of unemployment with respect to UI.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16526.

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Date of creation: Nov 2010
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Handle: RePEc:nbr:nberwo:16526

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  1. Optimal Unemployment Insurance over the Business Cycle
    by Christian Zimmermann in NEP-DGE blog on 2010-12-17 11:01:01
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