Labor Market Institutions and the Cost of Recessions

86 Pages Posted: 12 May 2017

See all articles by Tom Krebs

Tom Krebs

University of Mannheim

Martin Scheffel

University of Cologne - Center for Macroeconomic Research (CMR)

Date Written: April 2017

Abstract

This paper studies the effect of two labor market institutions, unemployment insurance (UI) and job search assistance (JSA), on the output cost and welfare cost of recessions. The paper develops a tractable incomplete-market model with search unemployment, skill depreciation during unemployment, and idiosyncratic as well as aggregate labor market risk. The theoretical analysis shows that an increase in JSA and a reduction in UI reduce the output cost of recessions by making the labor market more fluid along the job finding margin and thus making the economy more resilient to macroeconomic shocks. In contrast, the effect of JSA and UI on the welfare cost of recessions is in general ambiguous. The paper also provides a quantitative application to the German labor market reforms of 2003-2005, the so-called Hartz reforms, which improved JSA (Hartz III reform) and reduced UI (Hartz IV reform). According to the baseline calibration, the two labor market reforms led to a substantial reduction in the output cost of recessions and a moderate reduction in the welfare cost of recessions in Germany.

Keywords: Incomplete markets, Europe, Germany, Labor market institutions, cost of Recessions, German Labor Market Reform

JEL Classification: E21, E24, D52, J24

Suggested Citation

Krebs, Tom and Scheffel, Martin, Labor Market Institutions and the Cost of Recessions (April 2017). IMF Working Paper No. 17/87, Available at SSRN: https://ssrn.com/abstract=2967440

Tom Krebs (Contact Author)

University of Mannheim ( email )

Universitaetsbibliothek Mannheim
Zeitschriftenabteilung
Mannheim, 68131
Germany

Martin Scheffel

University of Cologne - Center for Macroeconomic Research (CMR) ( email )

Cologne
Germany

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