Employment Insurance and the Business Cycle

This paper quantitatively investigates the scope for improving welfare by making aspects of the unemployment insurance (UI) system depend on the state of the business cycle. A particular focus is the Canadian system of "Employment Insurance" (EI), which is designed in such a way that the generosity of benefits depends on the state of the macroeconomy. Simulations of a life-cycle model with heterogeneous agents and search frictions confirm the expectation that optimal UI systems are characterized by a substantial increase in generosity during recessions, when adverse labour market conditions reduce the importance of moral hazard while increasing the need for consumption insurance. It turns out, however, that the welfare improvements resulting from this sort of temporal differentiation of benefits are extremely small. The insurance against business cycle effects inherent in the Canadian EI system is welfare enhancing when considered in isolation; this insurance effect is, however, dominated by the welfare implications of the inter-regional redistribution effected by the system.