IDEAS home Printed from https://ideas.repec.org/p/ehl/lserod/35596.html
   My bibliography  Save this paper

Optimal unemployment insurance over the business cycle

Author

Listed:
  • Landais, Camille
  • Michaillat, Pascal
  • Saez, Emmanuel

Abstract

This paper analyzes optimal unemployment insurance over the business cycle in a search model in which unemployment stems from matching frictions (in booms) and job rationing (in recessions). Job rationing during recessions introduces two novel effects ignored in previous studies of optimal unemployment insurance. First, job-search efforts have little effect on aggregate unemployment because the number of jobs available is limited, independently of matching frictions. Second, while job-search efforts increase the individual probability of finding a job, they create a negative externality by reducing other jobseekers’ probability of finding one of the few available jobs. Both effects are captured by the positive and countercyclical wedge between micro-elasticity and macro-elasticity of unemployment with respect to net rewards from work. We derive a simple optimal unemployment insurance formula expressed in terms of those two elasticities and risk aversion. The formula coincides with the classical Baily-Chetty formula only when unemployment is low, and macro- and micro-elasticity are (almost) equal. The formula implies that the generosity of unemployment insurance should be countercyclical. We illustrate this result by simulating the optimal unemployment insurance over the business cycle in a dynamic stochastic general equilibrium model calibrated with US data.

Suggested Citation

  • Landais, Camille & Michaillat, Pascal & Saez, Emmanuel, 2010. "Optimal unemployment insurance over the business cycle," LSE Research Online Documents on Economics 35596, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:35596
    as

    Download full text from publisher

    File URL: http://eprints.lse.ac.uk/35596/
    File Function: Open access version.
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Cahuc, Pierre & Wasmer, Etienne, 2001. "Does Intrafirm Bargaining Matter In The Large Firm'S Matching Model?," Macroeconomic Dynamics, Cambridge University Press, vol. 5(5), pages 742-747, November.
    2. Torben M. Andersen & Michael Svarer, 2009. "Business Cycle Dependent Unemployment Insurance," Kiel Working Papers 1498, Kiel Institute for the World Economy.
    3. Fredriksson, Peter & Holmlund, Bertil, 2001. "Optimal Unemployment Insurance in Search Equilibrium," Journal of Labor Economics, University of Chicago Press, vol. 19(2), pages 370-399, April.
    4. Olivier Blanchard & Jordi Galí, 2010. "Labor Markets and Monetary Policy: A New Keynesian Model with Unemployment," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 1-30, April.
    5. Christopher A. Pissarides & Barbara Petrongolo, 2001. "Looking into the Black Box: A Survey of the Matching Function," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 390-431, June.
    6. Cahuc, Pierre & Lehmann, Etienne, 2000. "Should unemployment benefits decrease with the unemployment spell?," Journal of Public Economics, Elsevier, vol. 77(1), pages 135-153, July.
    7. Rasmus Lentz, 2009. "Optimal Unemployment Insurance in an Estimated Job Search Model with Savings," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(1), pages 37-57, January.
    8. Melvyn Coles & Adrian Masters, 2006. "Optimal Unemployment Insurance in a Matching Equilibrium," Journal of Labor Economics, University of Chicago Press, vol. 24(1), pages 109-138, January.
    9. Bruno Crépon & Esther Duflo & Marc Gurgand & Roland Rathelot & Philippe Zamora, 2013. "Do Labor Market Policies have Displacement Effects? Evidence from a Clustered Randomized Experiment," The Quarterly Journal of Economics, Oxford University Press, vol. 128(2), pages 531-580.
    10. Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780199279173.
    11. David Card & Raj Chetty & Andrea Weber, 2007. "Cash-on-Hand and Competing Models of Intertemporal Behavior: New Evidence from the Labor Market," The Quarterly Journal of Economics, Oxford University Press, vol. 122(4), pages 1511-1560.
    12. Kory Kroft & Matthew J. Notowidigdo, 2016. "Should Unemployment Insurance Vary with the Unemployment Rate? Theory and Evidence," Review of Economic Studies, Oxford University Press, vol. 83(3), pages 1092-1124.
    13. Kiley Michael T., 2003. "How Should Unemployment Benefits Respond to the Business Cycle?," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-22, July.
    14. Bemjamin Villena-Roldan, 2009. "Aggregate Implications of Employer Search and Recruiting Selection," 2009 Meeting Papers 97, Society for Economic Dynamics.
    15. Kroft, Kory, 2008. "Takeup, social multipliers and optimal social insurance," Journal of Public Economics, Elsevier, vol. 92(3-4), pages 722-737, April.
    16. Pascal Michaillat, 2012. "Do Matching Frictions Explain Unemployment? Not in Bad Times," American Economic Review, American Economic Association, vol. 102(4), pages 1721-1750, June.
    17. Haefke, Christian & Sonntag, Marcus & van Rens, Thijs, 2013. "Wage rigidity and job creation," Journal of Monetary Economics, Elsevier, vol. 60(8), pages 887-899.
    18. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 519-539, August.
    19. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
    20. Phillip B. Levine, 1993. "Spillover Effects between the Insured and Uninsured Unemployed," ILR Review, Cornell University, ILR School, vol. 47(1), pages 73-86, October.
    21. Pascal Michaillat & Emmanuel Saez, 2015. "Aggregate Demand, Idle Time, and Unemployment," The Quarterly Journal of Economics, Oxford University Press, vol. 130(2), pages 507-569.
    22. Lars A. Stole & Jeffrey Zwiebel, 1996. "Intra-firm Bargaining under Non-binding Contracts," Review of Economic Studies, Oxford University Press, vol. 63(3), pages 375-410.
    23. Burgess, Simon & Profit, Stefan, 2001. "Externalities in the matching of workers and firms in ritain," Labour Economics, Elsevier, vol. 8(3), pages 313-333, June.
    24. Christopher A. Pissarides, 2009. "The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?," Econometrica, Econometric Society, vol. 77(5), pages 1339-1369, September.
    25. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877, February.
    26. Moyen, Stéphane & Stähler, Nikolai, 2009. "Unemployment insurance and the business cycle: prolong benefit entitlements in bad times?," Discussion Paper Series 1: Economic Studies 2009,30, Deutsche Bundesbank.
    27. Michaillat, Pascal & Saez, Emmanuel, 2013. "A model of aggregate demand and unemployment," LSE Research Online Documents on Economics 51579, London School of Economics and Political Science, LSE Library.
    28. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
    29. Marc FERRACCI & Grégory JOLIVET & Gerard J van den Berg, 2009. "Treatment Evaluation in the Case of Interaction Within Markets," Working Papers 2009-22, Center for Research in Economics and Statistics.
    30. Silva, José Ignacio & Toledo, Manuel, 2009. "Labor Turnover Costs And The Cyclical Behavior Of Vacancies And Unemployment," Macroeconomic Dynamics, Cambridge University Press, vol. 13(S1), pages 76-96, May.
    31. Chetty, Raj, 2006. "A general formula for the optimal level of social insurance," Journal of Public Economics, Elsevier, vol. 90(10-11), pages 1879-1901, November.
    32. Moffitt, Robert, 1985. "Unemployment insurance and the distribution of unemployment spells," Journal of Econometrics, Elsevier, vol. 28(1), pages 85-101, April.
    33. Štěpán Jurajda & Frederick J. Tannery, 2003. "Unemployment Durations and Extended Unemployment Benefits in Local Labor Markets," ILR Review, Cornell University, ILR School, vol. 56(2), pages 324-348, January.
    34. Nicola Pavoni & G. L. Violante, 2007. "Optimal Welfare-to-Work Programs," Review of Economic Studies, Oxford University Press, vol. 74(1), pages 283-318.
    35. Bertil Holmlund, 1998. "Unemployment Insurance in Theory and Practice," Scandinavian Journal of Economics, Wiley Blackwell, vol. 100(1), pages 113-141, March.
    36. Pieter Gautier & Paul Muller & Bas van der Klaauw & Michael Rosholm & Michael Svarer, 2018. "Estimating Equilibrium Effects of Job Search Assistance," Journal of Labor Economics, University of Chicago Press, vol. 36(4), pages 1073-1125.
    37. Arulampalam, Wiji & Stewart, Mark B, 1995. "The Determinants of Individual Unemployment Durations in an Era of High Unemployment," Economic Journal, Royal Economic Society, vol. 105(429), pages 321-332, March.
    38. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 412-438, April.
    39. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.
    40. Arthur J. Hosios, 1990. "On The Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 279-298.
    41. Lalive, Rafael, 2008. "How do extended benefits affect unemployment duration A regression discontinuity approach," Journal of Econometrics, Elsevier, vol. 142(2), pages 785-806, February.
    42. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
    43. Raj Chetty, 2004. "Optimal Unemployment Insurance When Income Effects are Large," NBER Working Papers 10500, National Bureau of Economic Research, Inc.
    44. Meyer, Bruce D, 1990. "Unemployment Insurance and Unemployment Spells," Econometrica, Econometric Society, vol. 58(4), pages 757-782, July.
    45. Shavell, Steven & Weiss, Laurence, 1979. "The Optimal Payment of Unemployment Insurance Benefits over Time," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1347-1362, December.
    46. Diamond, Peter A, 1981. "Mobility Costs, Frictional Unemployment, and Efficiency," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 798-812, August.
    47. Narayana Kocherlakota, 2004. "Figuring out the Impact of Hidden Savings on Optimal Unemployment Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 541-554, July.
    48. Johannes F. Schmieder† & Till von Wachter & Stefan Bender, 2011. "The Effects Of Extended Unemployment Insurance Over The Business Cycle: Evidence From Regression Discontinuity Estimates Over Twenty Years," Boston University - Department of Economics - Working Papers Series WP2011-063, Boston University - Department of Economics.
    49. Johannes F. Schmieder & Till M. von Wachter & Stefan Bender, 2012. "The Long-Term Effects of Unemployment Insurance Extensions on Employment," NBER Working Papers 17814, National Bureau of Economic Research, Inc.
    50. Barron, John M & Berger, Mark C & Black, Dan A, 1997. "Employer Search, Training, and Vacancy Duration," Economic Inquiry, Western Economic Association International, vol. 35(1), pages 167-192, January.
    51. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
    52. Baily, Martin Neil, 1978. "Some aspects of optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 10(3), pages 379-402, December.
    53. Sánchez, Juan M., 2008. "Optimal state-contingent unemployment insurance," Economics Letters, Elsevier, vol. 98(3), pages 348-357, March.
    54. Richard Blundell & Monica Costa Dias & Costas Meghir & John Van Reenen, 2004. "Evaluating the Employment Impact of a Mandatory Job Search Program," Journal of the European Economic Association, MIT Press, vol. 2(4), pages 569-606, June.
    55. Acemoglu, Daron, 2001. "Good Jobs versus Bad Jobs," Journal of Labor Economics, University of Chicago Press, vol. 19(1), pages 1-21, January.
    56. Gruber, Jonathan, 1997. "The Consumption Smoothing Benefits of Unemployment Insurance," American Economic Review, American Economic Association, vol. 87(1), pages 192-205, March.
    57. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
    58. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-132, March.
    59. Robert E. Hall, 2005. "Employment Fluctuations with Equilibrium Wage Stickiness," American Economic Review, American Economic Association, vol. 95(1), pages 50-65, March.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Camille Landais & Pascal Michaillat & Emmanuel Saez, 2010. "A Macroeconomic Theory of Optimal Unemployment Insurance," NBER Working Papers 16526, National Bureau of Economic Research, Inc.
    2. Konstantinos Tatsiramos & Jan C. Ours, 2014. "Labor Market Effects Of Unemployment Insurance Design," Journal of Economic Surveys, Wiley Blackwell, vol. 28(2), pages 284-311, April.
    3. Rogerson, Richard & Shimer, Robert, 2011. "Search in Macroeconomic Models of the Labor Market," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 4, chapter 7, pages Pages: 61, Elsevier.
    4. Camille Landais & Pascal Michaillat & Emmanuel Saez, 2018. "A Macroeconomic Approach to Optimal Unemployment Insurance: Applications," American Economic Journal: Economic Policy, American Economic Association, vol. 10(2), pages 182-216, May.
    5. Michaillat, Pascal, 2011. "Fiscal Multipliers Over the Business Cycle," CEPR Discussion Papers 8610, C.E.P.R. Discussion Papers.
    6. Kohlbrecher, Britta, 2016. "Optimal Monetary Policy under Rigid Wages and Decreasing Returns," VfS Annual Conference 2016 (Augsburg): Demographic Change 145867, Verein für Socialpolitik / German Economic Association.
    7. Reichling, Felix, 2006. "Optimal Unemployment Insurance in Labor Market Equilibrium when Workers can Self-Insure," MPRA Paper 5362, University Library of Munich, Germany, revised 16 Oct 2007.
    8. Chetty, Nadarajan & Finkelstein, Amy Nadya, 2013. "Social Insurance: Connecting Theory to Data," Scholarly Articles 34330197, Harvard University Department of Economics.
    9. Andrew C. Johnston & Alexandre Mas, 2018. "Potential Unemployment Insurance Duration and Labor Supply: The Individual and Market-Level Response to a Benefit Cut," Journal of Political Economy, University of Chicago Press, vol. 126(6), pages 2480-2522.
    10. Pascal Michaillat, 2012. "Do Matching Frictions Explain Unemployment? Not in Bad Times," American Economic Review, American Economic Association, vol. 102(4), pages 1721-1750, June.
    11. Kurt Mitman & Stanislav Rabinovich, 2011. "Pro-cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model," PIER Working Paper Archive 11-023, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    12. Walter Nicholson & Karen Needels, "undated". "The EUC08 Program in Theoretical and Historical Perspective," Mathematica Policy Research Reports 9046cb11c3aa44c8a036a6e38, Mathematica Policy Research.
    13. Leo Kaas & Philipp Kircher, 2015. "Efficient Firm Dynamics in a Frictional Labor Market," American Economic Review, American Economic Association, vol. 105(10), pages 3030-3060, October.
    14. Camille Landais, 2015. "Assessing the Welfare Effects of Unemployment Benefits Using the Regression Kink Design," American Economic Journal: Economic Policy, American Economic Association, vol. 7(4), pages 243-278, November.
    15. Kory Kroft & Matthew J. Notowidigdo, 2016. "Should Unemployment Insurance Vary with the Unemployment Rate? Theory and Evidence," Review of Economic Studies, Oxford University Press, vol. 83(3), pages 1092-1124.
    16. Johannes F. Schmieder & Till von Wachter, 2016. "The Effects of Unemployment Insurance Benefits: New Evidence and Interpretation," Annual Review of Economics, Annual Reviews, vol. 8(1), pages 547-581, October.
    17. Kohlbrecher, Britta, 2019. "The (ir)relevance of real wage rigidity for optimal monetary policy," FAU Discussion Papers in Economics 07/2019, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.
    18. Michaillat, Pascal, 2012. "A theory of countercyclical government-consumption multiplier," LSE Research Online Documents on Economics 54277, London School of Economics and Political Science, LSE Library.
    19. Mitman, Kurt & Rabinovich, Stanislav, 2015. "Optimal unemployment insurance in an equilibrium business-cycle model," Journal of Monetary Economics, Elsevier, vol. 71(C), pages 99-118.
    20. Rafael Lalive & Camille Landais & Josef Zweimüller, 2015. "Market Externalities of Large Unemployment Insurance Extension Programs," American Economic Review, American Economic Association, vol. 105(12), pages 3564-3596, December.

    More about this item

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ehl:lserod:35596. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: https://edirc.repec.org/data/lsepsuk.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: LSERO Manager (email available below). General contact details of provider: https://edirc.repec.org/data/lsepsuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.