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

44 Pages Posted: 12 Aug 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: August 7, 2011

Abstract

We study the optimal provision of unemployment insurance (UI) over the business cycle. We use an equilibrium search and matching model with aggregate shocks to labor productivity, incorporating risk-averse workers, endogenous worker search effort decisions, and unemployment benefit expiration. We characterize the optimal UI policy, allowing both the benefit level and benefit duration to depend on the history of past aggregate shocks. We find that the optimal benefit is decreasing in current productivity and decreasing in current unemployment. 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 U.S. UI system, the optimal history-dependent benefits smooth cyclical fluctuations in unemployment and deliver substantial 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 (August 7, 2011). PIER Working Paper No. 11-023. Available at SSRN: https://ssrn.com/abstract=1908683 or http://dx.doi.org/10.2139/ssrn.1908683

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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