The Optimal Timing of Unemployment Benefits: Theory and Evidence from Sweden

This paper provides a general framework to analyze the optimal time profile of benefits during the unemployment spell. We derive simple sufficient-statistics formula capturing the insurance value and incentive costs of unemployment benefits at different times during unemployment. Our general approach allows to evaluate the separate arguments for increasing or decreasing profiles put forward in the theoretical literature. Using administrative data in Sweden on unemployment, income and wealth, we find that the insurance value is fairly constant over the unemployment spell. From the start of the spell savings and credit play only a limited role in smoothing the loss of earnings. We also exploit duration-dependent kinks in the replacement rate and find that the welfare-relevant unemployment elasticity is twice as high for benefits in the first twenty weeks of the spell compared to benefits given after 20 weeks. Our evidence therefore indicates that the recent change from a flat to a declining benefit profile in Sweden has decreased welfare. The local welfare gains push towards an increasing rather than decreasing benefit profile over the spell.