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Optimal labor-market policy in recessions

  • Philip Jung
  • Keith Kuester

The authors examine the optimal labor market-policy mix over the business cycle. In a search and matching model with risk-averse workers, endogenous hiring and separation, and unobservable search effort they first show how to decentralize the constrained-efficient allocation. This can be achieved by a combination of a production tax and three labor-market policy instruments, namely, a vacancy subsidy, a layoff tax and unemployment benefits. The authors derive analytical expressions for the optimal setting of each of these for the steady state and for the business cycle. Their propositions suggest that hiring subsidies, layoff taxes and the replacement rate of unemployment insurance should all rise in recessions. The authors find this confirmed in a calibration targeted to the U.S. economy.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 11-48.

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Date of creation: 2011
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Handle: RePEc:fip:fedpwp:11-48
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  1. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
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  3. Cahuc, Pierre & Zylberberg, André, 2008. "Optimum income taxation and layoff taxes," Journal of Public Economics, Elsevier, vol. 92(10-11), pages 2003-2019, October.
  4. Akerlof, George A & Miyazaki, Hajime, 1980. "The Implicit Contract Theory of Unemployment Meets the Wage Bill Argument," Review of Economic Studies, Wiley Blackwell, vol. 47(2), pages 321-38, January.
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  7. Marcelo Veracierto, 2004. "Firing Costs and Business Cycle Fluctuations," 2004 Meeting Papers 590, Society for Economic Dynamics.
  8. Christopher Pissarides, 2007. "The unemployment volatility puzzle: is wage stickiness the answer?," LSE Research Online Documents on Economics 4460, London School of Economics and Political Science, LSE Library.
  9. Olivier J. Blanchard & Jean Tirole, 2008. "The Joint Design of Unemployment Insurance and Employment Protection: A First Pass," Journal of the European Economic Association, MIT Press, vol. 6(1), pages 45-77, 03.
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  11. Landais, Camille & Michaillat, Pascal & Saez, Emmanuel, 2010. "Optimal Unemployment Insurance over the Business Cycle," CEPR Discussion Papers 8132, C.E.P.R. Discussion Papers.
  12. 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.
  13. Camille Landais & Pascal Michaillat & Emmanuel Saez, 2010. "A Macroeconomic Theory of Optimal Unemployment Insurance," NBER Working Papers 16526, National Bureau of Economic Research, Inc.
  14. David Domeij, 2005. "Optimal Capital Taxation and Labor Market Search," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(3), pages 623-650, July.
  15. Garey Ramey & Wouter J. den Haan & Joel Watson, 2000. "Job Destruction and Propagation of Shocks," American Economic Review, American Economic Association, vol. 90(3), pages 482-498, June.
  16. Marcus Hagedorn & Iourii Manovskii, 2008. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies Revisited," American Economic Review, American Economic Association, vol. 98(4), pages 1692-1706, September.
  17. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 397-415, July.
  18. Engen, Eric M. & Gruber, Jonathan, 2001. "Unemployment insurance and precautionary saving," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 545-579, June.
  19. Barnichon, Regis, 2010. "Building a composite Help-Wanted Index," Economics Letters, Elsevier, vol. 109(3), pages 175-178, December.
  20. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 915-38, October.
  21. Raj Chetty, 2005. "A General Formula for the Optimal Level of Social Insurance," NBER Working Papers 11386, National Bureau of Economic Research, Inc.
  22. Coles, Melvyn, 2008. "Optimal unemployment policy in a matching equilibrium," Labour Economics, Elsevier, vol. 15(4), pages 537-559, August.
  23. Lars Ljungqvist & Thomas J. Sargent, 2008. "Two Questions about European Unemployment," Econometrica, Econometric Society, vol. 76(1), pages 1-29, 01.
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