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Optimal Unemployment Insurance Over the Business Cycle

  • Camille Landais
  • Pascal Michaillat
  • Emmanuel Saez

This paper characterizes optimal unemployment insurance (UI) over the business cycle using a model of equilibrium unemployment in which jobs are rationed in recession. It offers a simple optimal UI formula that can be applied to a broad class of equilibrium unemployment models. In addition to the usual statistics (risk aversion and micro-elasticity of unemployment with respect to UI), a macro-elasticity appears in the formula to capture the macroeconomic impact of UI on unemployment. In a model with job rationing, the formula implies that optimal UI is countercyclical. This result arises because in recession, jobs are lacking irrespective of job search. Therefore (1) a higher aggregate search effort cannot reduce aggregate unemployment much; and (2) individual search effort creates a negative externality by reducing other jobseekers' probability of finding a job as in a rat race. Hence the social benefits of job search are low. In a calibrated model, optimal UI increases significantly in recession. This quantitative result holds whether the government adjusts the level or duration of benefits; whether it balances its budget each period or uses deficit spending.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1078.

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Date of creation: Sep 2011
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Handle: RePEc:cep:cepdps:dp1078
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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