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A Macroeconomic Theory of Optimal Unemployment Insurance

  • Camille Landais
  • Pascal Michaillat
  • Emmanuel Saez

This paper develops a theory of optimal unemployment insurance (UI) that accounts not only for workers’ job-search behavior but also for firms’ hiring behavior. The theoretical framework is a matching model of the labor market in which the production function, wage mechanism, matching function, and utility function are general. The labor market tightness plays a central role in the theory. The tightness is defined as the ratio of job vacancies to aggregate job-search effort and is determined in equilibrium to equalize labor demand and supply. We show that the optimal level of UI is the sum of a conventional Baily-Chetty term, which captures the trade-off between insurance and job-search incentives, and a correction term, which is positive if UI brings labor market tightness closer to its efficient level. Hence, optimal UI depends on whether tightness is inefficiently low or inefficiently high and whether UI raises or lowers tightness. For instance, if tightness is inefficiently low, optimal UI is more generous than the Baily-Chetty level if UI raises tightness and less generous if UI lowers tightness. Depending on the production function and wage mechanism, UI could raise tightness, for example by alleviating the rat race for jobs, or lower tightness, for example by increasing bargained wages. To determine whether UI raises or lowers tightness in practice, we develop an empirical criterion; the criterion involves comparing the microelasticity and macroelasticity of unemployment with respect to UI. Since tightness is subject to large fluctuations over the business cycle, our theory has direct implications for the cyclicality of optimal UI.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16526.

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Date of creation: Nov 2010
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Handle: RePEc:nbr:nberwo:16526
Note: EFG PE
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  1. Gary D. Hansen & Ayse Imrohoroglu, 1990. "The Role of Unemployment Insurance in an Economy with Liquidity Constraints and Moral Hazard," UCLA Economics Working Papers 583, UCLA Department of Economics.
  2. Sánchez, Juan M., 2008. "Optimal state-contingent unemployment insurance," Economics Letters, Elsevier, vol. 98(3), pages 348-357, March.
  3. Pascal Michaillat, 2012. "Do Matching Frictions Explain Unemployment? Not in Bad Times," American Economic Review, American Economic Association, vol. 102(4), pages 1721-50, June.
  4. Christian Haefke & Marcus Sonntag & Thijs van Rens, 2006. "Wage Rigidity and Job Creation," 2006 Meeting Papers 773, Society for Economic Dynamics.
  5. 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, Research Centre.
  6. Fredriksson, Peter & Holmlund, Bertil, 2001. "Optimal Unemployment Insurance in Search Equilibrium," Journal of Labor Economics, University of Chicago Press, vol. 19(2), pages 370-99, April.
  7. Steven Shavell & Laurence Weiss, 1978. "The Optimal Payment of Unemployment Insurance Benefits over Time," Cowles Foundation Discussion Papers 503, Cowles Foundation for Research in Economics, Yale University.
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  10. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
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  12. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  13. 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.
  14. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-32, March.
  15. 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.
  16. 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.
  17. Andersen, Torben M & Svarer, Michael, 2009. "Business Cycle Dependent Unemployment Insurance," CEPR Discussion Papers 7334, C.E.P.R. Discussion Papers.
  18. Moffitt, Robert, 1985. "Unemployment insurance and the distribution of unemployment spells," Journal of Econometrics, Elsevier, vol. 28(1), pages 85-101, April.
  19. 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.
  20. Hopenhayn, Hugo A & Nicolini, Juan Pablo, 1997. "Optimal Unemployment Insurance," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 412-38, April.
  21. 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 321-32, March.
  22. 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.
  23. 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.
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