Unemployment Insurance with Limited Duration and Variable Replacement Ratio - Effects on Optimal Search

This paper analyses the effects of an unemployment insurance with limited potential duration in a job search model with endogenous effort. Both constant and declining time sequence of benefits are considered. The model extends the framework of Pissarides (2000) in assuming that workers maximise the joint value of unemployment search and the remaining unemployment benefits. Wage formation and aggregate labour market tightness are exogenously determined. We simulate the model numerically with parameters chosen to fit to the stylised facts of the Finnish labour market. We find that introduction of a benefit system reduces the effort of those who have been unemployed for a relatively short period, but increases the effort of those who have been unemployed for longer period. Concerning the declining time sequence of benefits, we find that if a faster depreciation of the replacement ratio is accompanied by a simultaneous increase in the initial benefit level so as to keep the present value of the insurance program intact, the search effort is either increased or remains unchanged irrespective of the unemployment duration. Such a reform is appealing for at least two reasons: it leaves the expected government spending intact and is likely to be neutral in terms of the wage pressure.