We develop a numerically solved equilibrium model of the labor market to study the effect of unemployment insurance (UI) over the business cycle. This model combines sequential job search, optimal job offer, layoff, and recall decisions, an aggregate productivity cycle, and details of an actual (namely, the Canadian) UI system. Optimal worker (firm) behavior is characterized by a dynamic programming problem conditional upon beliefs about the behavior of firms (workers). In equilibrium beliefs are consistent with the optimal decisions of other agents. The equilibrium beliefs are found using a nested algorithm in which simulations of the economy are used to iterate on beliefs while re-solving for optimal decisions. Some of the model's parameters are used to match simulated moments to data on labor market outcomes for young Canadian men. Simulations of recent changes to the UI system suggest that they will raise average unemployment rates and increase short-term layoffs and recalls among young Canadians. Eliminating UI altogether would significantly lower the unemployment rate among young men as well as lower average observed wages. Under the previous UI rules each month of UI is associated with .86 more months of unemployment than without UI. Under the new rules the ratio is 1.46: each two people on UI can be thought of as generating a third unemployed person not receiving UI through the changes in firm and worker decisions generated by the UI policy. In general, UI policy is found to have complicated effects on the timing of cycles in wages and other variables relative to the productivity cycle.
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number
965.
Laura Brown & Christopher Ferrall, 2003.
"Unemployment insurance and the business cycle,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(3), pages 863-894, 08.
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Find related papers by JEL classification: L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior D2 - Microeconomics - - Production and Organizations J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs C4 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics
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