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Optimal Unemployment Insurance over the Business Cycle

  • Camille Landais

    ()

    (London School of Economics (LSE), Economics Department)

  • Pascal Michaillat

    ()

    (London School of Economics (LSE), Economics Department
    Centre for Macroeconomics (CFM))

  • Emmanuel Saez

    ()

    (University of California-Berkeley, Department of Economics)

This paper analyzes optimal unemployment insurance (UI) over the business cycle. We consider a general matching model of the labor market. For a given UI, the economy is efficient if tightness satisfies a generalized Hosios condition, slack if tightness is too low, and tight if tightness is too high. The optimal UI formula is the sum of the standard Baily-Chetty term, which trades off search incentives and insurance, and an externality-correction term, which is positive if UI brings the economy closer to efficiency and negative otherwise. Our formula therefore deviates from the Baily-Chetty formula when the economy is inefficient and UI affects labor market tightness. In a model with rigid wages and concave production function, UI increases tightness; hence, UI should be more generous than in the Baily-Chetty formula when the economy is slack, and less generous otherwise. In contrast, in a model with linear production function and Nash bargaining, UI increases wages and reduces tightness; hence, UI should be less generous than in the Baily-Chetty formula when the economy is slack, and more generous otherwise. Deviations from the Baily-Chetty formula can be quantitatively large using realistic empirical parameters.

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Paper provided by Centre for Macroeconomics (CFM) in its series Discussion Papers with number 1303.

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Length: 43 pages
Date of creation: Oct 2013
Date of revision:
Handle: RePEc:cfm:wpaper:1303
Contact details of provider: Web page: http://www.centreformacroeconomics.ac.uk/

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