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Labor Market Institutions and the Cost of Recessions

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  • Martin Scheffel

    (University of Cologne)

  • Tom Krebs

    (University of Mannheim)

Abstract

This paper studies the effect of two labor market institutions, unemployment insurance (UI) and job search assistance (JSA), on the output cost and welfare cost of recessions. The paper develops a tractable incomplete-market model with search unemployment, skill depreciation during unemployment, and idiosyncratic as well as aggregate labor market risk. The theoretical analysis shows that an increase in JSA and a reduction in UI reduce the output cost of recessions by making the labor market more fluid along the job finding margin and thus making the economy more resilient to macroeconomic shocks. In contrast, the effect of JSA and UI on the welfare cost of recessions is in general ambiguous. The paper also provides a quantitative application to the German labor market reforms of 2003-2005, the so-called Hartz reforms, which improved JSA (Hartz III reform) and reduced UI (Hartz IV reform). According to the baseline calibration, the two labor market reforms led to a substantial reduction in the output cost of recessions and a moderate reduction in the welfare cost of recessions in Germany.

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  • Martin Scheffel & Tom Krebs, 2017. "Labor Market Institutions and the Cost of Recessions," 2017 Meeting Papers 1438, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:1438
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    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

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