Working Paper: CEPR ID: DP15748
Authors: Kurt Mitman; Stanislav Rabinovich
Abstract: We investigate the optimal response of unemployment insurance to economic shocks, both with and without commitment. The optimal policy with commitment follows a modified Baily-Chetty formula that accounts for job search responses to future UI benefit changes. As a result, the optimal policy with commitment tends to front-load UI, unlike the optimal discretionary policy. In response to shocks intended to mimic those that induced the COVID-19 recession, we find that a large and transitory increase in UI is optimal; and that a policy rule contingent on the change in unemployment, rather than its level, is a good approximation to the optimal policy.
Keywords: unemployment insurance; optimal policy; Markov perfect equilibrium
JEL Codes: J65; E6; H1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal policy with commitment (E61) | frontloaded unemployment insurance (UI) benefits (J65) |
| large and transitory increase in UI (J65) | optimal response to shocks (C61) |
| moral hazard cost of UI (J65) | influenced by search efficiency (D83) |
| government commitment power (H11) | better management of UI benefits (J65) |
| optimal policy (C61) | trade-off between consumption smoothing benefits and moral hazard costs (D15) |