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Optimal Unemployment Insurance over the Business Cycle

  • Pascal Michaillat

    (London School of Economics)

  • Emmanuel Saez

    (University of California at Berkeley)

  • Camille Landais

    (Stanford University (SIEPR))

This paper analyzes optimal unemployment insurance over the business cycle in a search model in which unemployment stems from matching frictions (in booms) and job rationing (in recessions). Job rationing during recessions introduces two novel effects ignored in previous studies of optimal unemployment insurance. First, job-search efforts have little effect on aggregate unemployment because the number of jobs available is limited, independently of matching frictions. Second, while job-search efforts increase the individual probability of finding a job, they create a negative externality by reducing other jobseekers' probability of finding one of the few available jobs. Both effects are captured by the positive and countercyclical wedge between micro-elasticity and macro-elasticity of unemployment with respect to net rewards from work. We derive a simple optimal unemployment insurance formula expressed in terms of those two elasticities and risk aversion. The formula coincides with the classical Baily-Chetty formula only when unemployment is low, and macro- and micro-elasticity are (almost) equal. The formula implies that the generosity of unemployment insurance should be countercyclical. We illustrate this result by simulating the optimal unemployment insurance over the business cycle in a dynamic stochastic general equilibrium model calibrated with US data.

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Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 124.

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Date of creation: 2011
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Handle: RePEc:red:sed011:124
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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