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

24 Pages Posted: 4 May 2011

See all articles by Kurt Mitman

Kurt Mitman

IIES

Stanislav Rabinovich

University of Pennsylvania - Department of Economics; Amherst College - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: February 15, 2011

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.

Keywords: Unemployment Insurance, Business Cycles, Optimal Policy, Search and Matching

JEL Classification: E24,E32,H21,J65

Suggested Citation

Mitman, Kurt and Rabinovich, Stanislav, Pro-Cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model (February 15, 2011). PIER Working Paper No. 11-010. Available at SSRN: https://ssrn.com/abstract=1831334 or http://dx.doi.org/10.2139/ssrn.1831334

Kurt Mitman (Contact Author)

IIES ( email )

Stockholm, SE-10691
Sweden

HOME PAGE: http://kurtmitman.com

Stanislav Rabinovich

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

Amherst College - Department of Economics ( email )

P.O. Box 5000
Amherst, MA 01002-5000
United States

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