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Pro-Cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model

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  • Kurt Mitman

    ()
    (Department of Economics, University of Pennsylvania)

  • Stanislav Rabinovich

    ()
    (Department of Economics, University of Pennsylvania)

Abstract

We study the optimal provision of unemployment insurance (UI) over the business cycle. We consider an equilibrium Mortensen-Pissarides search and matching model with risk-averse workers and aggregate shocks to labor productivity. Both the vacancy creation decisions of firms and the search effort decisions of workers respond endogenously to aggregate shocks as well as to changes in UI policy. We characterize the optimal history-dependent UI policy. We find that, all else equal, the optimal benefit is decreasing in current productivity and decreasing in current unemployment. Optimal benefits are therefore lowest when current productivity is high and current unemployment is high. The optimal path of benefits reacts non-monotonically to a productivity shock. Following a drop in productivity, benefits initially rise in order to provide short-run relief to the unemployed and stabilize wages, but then fall significantly below their pre-recession level, in order to speed up the subsequent recovery. Under the optimal policy, the path of benefits is pro-cyclical overall. As compared to the existing US UI system, the optimal history-dependent benefits smooth cyclical fluctuations in unemployment and deliver non-negligible welfare gains.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 11-010.

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Length: 24 pages
Date of creation: 15 Feb 2011
Date of revision:
Handle: RePEc:pen:papers:11-010

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Keywords: Unemployment Insurance; Business Cycles; Optimal Policy; Search and Matching;

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  1. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Pro-Cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model
    by Christian Zimmermann in NEP-DGE blog on 2011-05-15 14:18:51
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Cited by:
  1. Pollak, Andreas, 2013. "Employment Insurance and the Business Cycle," MPRA Paper 49358, University Library of Munich, Germany.
  2. Mark Strøm Kristoffersen, 2012. "Business Cycle Dependent Unemployment Benefits with Wealth Heterogeneity and Precautionary Savings," Economics Working Papers 2012-19, School of Economics and Management, University of Aarhus.
  3. Keith Kuester & Philip Jung, 2012. "Optimal Labor-Market Policy in Recessions," 2012 Meeting Papers 186, Society for Economic Dynamics.
  4. Ek, Susanne, 2012. "Unemployment benefits or taxes: How should policy makers redistribute income over the business cycle?," Working Paper Series, Center for Labor Studies 2012:4, Uppsala University, Department of Economics.
  5. Tatsiramos, Konstantinos & van Ours, Jan C., 2012. "Labor Market Effects of Unemployment Insurance Design," IZA Discussion Papers 6950, Institute for the Study of Labor (IZA).
  6. David L. Fuller & Marianna Kudlyak & Damba Lkhagvasuren, 2013. "Productivity insurance: the role of unemployment benefits in a multi-sector model," Working Paper 13-11, Federal Reserve Bank of Richmond.
  7. Stanislav Rabinovich & Kurt Mitman, 2012. "Unemployment Benefits Caused Jobless Recoveries!?," 2012 Meeting Papers 1112, Society for Economic Dynamics.
  8. Julien Albertini & Arthur Poirier, 2014. "Unemployment benefits extensions at the zero lower bound on nominal interest rate," SFB 649 Discussion Papers SFB649DP2014-019, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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