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

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Author Info

  • 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 use an equilibrium search and matching model with aggregate shocks to labor productivity, incorporating risk-averse workers, endogenous worker search effort decisions, and unemployment benefit expiration. We characterize the optimal UI policy, allowing both the benefit level and benefit duration to depend on the history of past aggregate shocks. We find that the optimal benefit is decreasing in current productivity and decreasing in current unemployment. 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 substantial 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 11-023.

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Length: 43 pages
Date of creation: 07 Aug 2011
Date of revision:
Handle: RePEc:pen:papers:11-023

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

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  1. Marcus Hagedorn & Iourii Manovskii, 2008. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited," American Economic Review, American Economic Association, American Economic Association, vol. 98(4), pages 1692-1706, September.
  2. Lehmann E. & Van Der Linden B., 2004. "On the Optimality of Search Matching Equilibrium when workers are risk adverse," Working Papers ERMES, ERMES, University Paris 2 0406, ERMES, University Paris 2.
  3. Fredriksson, Peter & Holmlund, Bertil, 1998. "Optimal Unemployment Insurance in Search Equilibrium," Working Paper Series, Uppsala University, Department of Economics 1998:2, Uppsala University, Department of Economics.
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  16. Cahuc, Pierre & Lehmann, Etienne, 2000. "Should unemployment benefits decrease with the unemployment spell?," Journal of Public Economics, Elsevier, Elsevier, vol. 77(1), pages 135-153, July.
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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. 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.
  2. Jung, Philip & Kuester, Keith, 2011. "Optimal Labor-Market Policy in Recessions," Working Papers, University of Mannheim, Department of Economics 11-1, University of Mannheim, Department of Economics.
  3. Ek Spector, Susanne, 2012. "Unemployment Benefits or Taxes: How Should Policy Makers Redistribute Income over the Business Cycle?," IZA Discussion Papers 6308, Institute for the Study of Labor (IZA).
  4. Tatsiramos, K. & Ours, J.C. van, 2012. "Labor Market Effects of Unemployment Insurance Design," Discussion Paper, Tilburg University, Center for Economic Research 2012-082, Tilburg University, Center for Economic Research.
  5. Stanislav Rabinovich & Kurt Mitman, 2012. "Unemployment Benefits Caused Jobless Recoveries!?," 2012 Meeting Papers, Society for Economic Dynamics 1112, Society for Economic Dynamics.
  6. Mark Strøm Kristoffersen, 2012. "Business Cycle Dependent Unemployment Benefits with Wealth Heterogeneity and Precautionary Savings," Economics Working Papers, School of Economics and Management, University of Aarhus 2012-19, School of Economics and Management, University of Aarhus.
  7. David L. Fuller & Marianna Kudlyak & Damba Lkhagvasuren, 2013. "Productivity insurance: the role of unemployment benefits in a multi-sector model," Working Paper, Federal Reserve Bank of Richmond 13-11, Federal Reserve Bank of Richmond.
  8. Pollak, Andreas, 2013. "Employment Insurance and the Business Cycle," MPRA Paper 49358, University Library of Munich, Germany.

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