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Optimal Labor-Market Policy in Recessions

  • Jung, Philip
  • Kuester, Keith

We 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 we 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. We derive analytical expressions for the optimal setting of each of these for the steady state and for the business cycle. Our propositions suggest that hiring subsidies, layoff taxes and the replacement rate of unemployment insurance should all rise in recessions. We find this confirmed in a calibration targeted to the U.S. economy.

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File URL: https://ub-madoc.bib.uni-mannheim.de/29630/1/WP2011_1.pdf
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Paper provided by University of Mannheim, Department of Economics in its series Working Papers with number 11-1.

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Date of creation: 2011
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Handle: RePEc:mnh:wpaper:29630
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  5. Marcelo Veracierto, 2004. "Firing Costs and Business Cycle Fluctuations," 2004 Meeting Papers 445c, Society for Economic Dynamics.
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  17. 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.
  18. Stanislav Rabinovich & Kurt Mitman, 2011. "Pro-cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model," 2011 Meeting Papers 1247, Society for Economic Dynamics.
  19. 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.
  20. Baily, Martin Neil, 1978. "Some aspects of optimal unemployment insurance," Journal of Public Economics, Elsevier, vol. 10(3), pages 379-402, December.
  21. 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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