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Pro-cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model

Author

Listed:
  • Stanislav Rabinovich

    (University of Pennsylvania)

  • Kurt Mitman

    (University of Pennsylvania)

Abstract

We study the optimal provision of unemployment insurance (UI) over the business cycle. We consider an equilibrium Mortensen-Pissarides search and matching model with risk-averse workers and aggregate shocks to labor productivity. Both the vacancy creation decisions of firms and the search effort decisions of workers respond endogenously to aggregate shocks as well as to changes in UI policy. We characterize the optimal history-dependent UI policy. We find that, all else equal, the optimal benefit is decreasing in current productivity and decreasing in current unemployment. Optimal benefits are therefore lowest when current productivity is high and current unemployment is high. The optimal path of benefits reacts non-monotonically to a productivity shock. Following a drop in productivity, benefits initially rise in order to provide short-run relief to the unemployed and stabilize wages, but then fall significantly below their pre-recession level, in order to speed up the subsequent recovery. Under the optimal policy, the path of benefits is pro-cyclical overall. As compared to the existing US UI system, the optimal history-dependent benefits smooth cyclical fluctuations in unemployment and deliver non-negligible welfare gains.

Suggested Citation

  • 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.
  • Handle: RePEc:red:sed011:1247
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    References listed on IDEAS

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    Cited by:

    1. Ricardo Reis & Alisdair McKay, 2015. "Optimal Automatic Stabilizers," 2015 Meeting Papers 608, Society for Economic Dynamics.
    2. Richard J. Sullivan & Zhu Wang, 2005. "Internet banking: an exploration in technology diffusion and impact," Payments System Research Working Paper PSR WP 05-05, Federal Reserve Bank of Kansas City.
    3. Fuller, David L. & Kudlyak, Marianna & Lkhagvasuren, Damba, 2014. "Productivity insurance: The role of unemployment benefits in a multi-sector model," Journal of Economic Dynamics and Control, Elsevier, vol. 47(C), pages 39-53.
    4. Torben M. Andersen, 2014. "Tuning unemployment insurance to the business cycle," IZA World of Labor, Institute for the Study of Labor (IZA), pages 1-54.
    5. Nakajima, Makoto, 2012. "A quantitative analysis of unemployment benefit extensions," Journal of Monetary Economics, Elsevier, pages 686-702.
    6. Pollak, Andreas, 2013. "Employment Insurance and the Business Cycle," MPRA Paper 49358, University Library of Munich, Germany.
    7. Bassanini, Andrea, 2015. "A Bitter Medicine? Short-term Employment Impact of Deregulation in Network Industries," IZA Discussion Papers 9187, Institute for the Study of Labor (IZA).
    8. Konstantinos Tatsiramos & Jan C. Ours, 2014. "Labor Market Effects Of Unemployment Insurance Design," Journal of Economic Surveys, Wiley Blackwell, pages 284-311.
    9. Markus K. Brunnermeier & Luis Garicano & Philip R. Lane & Marco Pagano & Ricardo Reis & Tano Santos & David Thesmar & Stijn Van Nieuwerburgh & Dimitri Vayanos, 2016. "The Sovereign-Bank Diabolic Loop and ESBies," American Economic Review, American Economic Association, pages 508-512.
    10. Ricardo Reis & Alisdair McKay, 2015. "Optimal Automatic Stabilizers," 2015 Meeting Papers 608, Society for Economic Dynamics.
    11. Philip Jung & Keith Kuester, 2015. "Optimal Labor-Market Policy in Recessions," American Economic Journal: Macroeconomics, American Economic Association, pages 124-156.
    12. Mark Strøm Kristoffersen, 2012. "Business Cycle Dependent Unemployment Benefits with Wealth Heterogeneity and Precautionary Savings," Economics Working Papers 2012-19, Department of Economics and Business Economics, Aarhus University.
    13. Ek, Susanne, 2012. "Unemployment benefits or taxes: How should policy makers redistribute income over the business cycle?," Working Paper Series 2012:2, Uppsala University, Department of Economics.
    14. Drozd, Lukasz A. & Nosal, Jaromir B., 2010. "Pricing to Market in Business Cycle Models," MPRA Paper 22513, University Library of Munich, Germany.
    15. Julien Albertini & Arthur Poirier, 2014. "Unemployment benefits extensions at the zero lower bound on nominal interest rate," SFB 649 Discussion Papers SFB649DP2014-019, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

    More about this item

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings

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