Optimal Unemployment Insurance Over the Business Cycle

72 Pages Posted: 6 Dec 2010

See all articles by Camille Landais

Camille Landais

London School of Economics & Political Science (LSE)

Pascal Michaillat

Brown University - Department of Economics

Emmanuel Saez

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: December 2010

Abstract

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.

Keywords: Business Cycle, Unemployment insurance

JEL Classification: E24, E32, H21, H23

Suggested Citation

Landais, Camille and Michaillat, Pascal and Saez, Emmanuel, Optimal Unemployment Insurance Over the Business Cycle (December 2010). CEPR Discussion Paper No. DP8132. Available at SSRN: https://ssrn.com/abstract=1718927

Camille Landais (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Pascal Michaillat

Brown University - Department of Economics ( email )

64 Waterman Street
Providence, RI 02912
United States

HOME PAGE: http://www.pascalmichaillat.org

Emmanuel Saez

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-642-4631 (Phone)
510-642-6615 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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