On the Design of a European Unemployment Insurance Mechanism

European labour markets are subject to idiosyncratic shocks (and idiosyncratic responses to common shocks), resulting in countercyclical unemployment expenses difficult to accommodate under existing, fiscal compact, budget rules. These and other factors (solidarity, labour market integration) provide a rationale for European unemployment risk sharing. We study the potential benefits, and problems, of creating a European Unemployment Insurance Mechanism (EUIM). Following Krusell et al. (2011 and 2015), we use a dynamic general equilibrium model with search frictions to analyze workers' flows (employment, unemployment and inactivity) and their cyclical properties, to assess the potential benefits of a EUIM under alternative common (and jointly financed) unemployment insurance policies. Our analysis shows that country-specific structural differences play a determinant role in explaining labour market differences, leaving limited space for welfare improvements with an EUIM. The framework would also allow to study the optimal design of an EUIM, subject to redistributional and incentive (moral hazard and free riding) constraints.