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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 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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References

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  1. Marcus Hagedorn & Iourii Manovskii, 2007. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited," IEW - Working Papers 351, Institute for Empirical Research in Economics - University of Zurich.
  2. Andersen, Torben M & Svarer, Michael, 2009. "Business Cycle Dependent Unemployment Insurance," CEPR Discussion Papers 7334, C.E.P.R. Discussion Papers.
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  10. 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.
  11. Steven Shavell & Laurence Weiss, 1978. "The Optimal Payment of Unemployment Insurance Benefits over Time," Cowles Foundation Discussion Papers 503, Cowles Foundation for Research in Economics, Yale University.
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  17. Landais, Camille & Michaillat, Pascal & Saez, Emmanuel, 2010. "Optimal Unemployment Insurance over the Business Cycle," CEPR Discussion Papers 8132, C.E.P.R. Discussion Papers.
  18. Wouter J. den Haan & Garey Ramey & Joel Watson, 1997. "Job Destruction and Propagation of Shocks," NBER Working Papers 6275, National Bureau of Economic Research, Inc.
  19. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
  20. Baily, Martin Neil, 1978. "Some aspects of optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 10(3), pages 379-402, December.
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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. Ek, 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).
  2. Tatsiramos, Konstantinos & van Ours, Jan C, 2012. "Labor Market Effects of Unemployment Insurance Design," CEPR Discussion Papers 9196, C.E.P.R. Discussion Papers.
  3. Philip Jung & Keith Kuester, 2011. "Optimal labor-market policy in recessions," Working Papers 11-48, Federal Reserve Bank of Philadelphia.

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