How Should Unemployment Benefits Respond to the Business Cycle?

30 Pages Posted: 15 May 2003

See all articles by Michael T. Kiley

Michael T. Kiley

Board of Governors of the Federal Reserve System

Date Written: February 2003

Abstract

Unemployment insurance programs balance the benefits of consumption smoothing for unemployed workers against the disincentive effects of unemployment benefits. Such a balancing of benefits and costs is likely sensitive to the cyclical state of the economy, and hence the generosity of benefits should also respond to the cyclical state of the economy. The nature of such responses in an optimal unemployment insurance (UI) program is analyzed in a simple model. The results suggest that an optimal UI program would increase the initial level of benefits and probably extend higher benefits over time in response to a recessionary shock. A simple extension of benefits, such as exists automatically in the system in the United States, provides both poorer insurance and poorer incentives than the optimal program, and does so at a higher cost. Moreover, the current UI system in the U.S. provides a substantially higher level of welfare to workers who lose jobs during tight labor markets.

Keywords: Unemployment insurance, time-varying benefits

JEL Classification: E24, J65, J64

Suggested Citation

Kiley, Michael T., How Should Unemployment Benefits Respond to the Business Cycle? (February 2003). FEDS Working Paper No. 2003-01. Available at SSRN: https://ssrn.com/abstract=387200 or http://dx.doi.org/10.2139/ssrn.387200

Michael T. Kiley (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2448 (Phone)
202-452-5296 (Fax)

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