Working Paper: CEPR ID: DP8132
Authors: Camille Landais; Pascal Michaillat; Emmanuel Saez
Abstract: This paper analyzes optimal unemployment insurance over the business cycle in a search model in which unemployment stems from matching frictions (in booms) and job rationing (in recessions). Job rationing during recessions introduces two novel effects ignored in previous studies of optimal unemployment insurance. First, job-search efforts have little effect on aggregate unemployment because the number of jobs available is limited, independently of matching frictions. Second, while job-search efforts increase the individual probability of finding a job, they create a negative externality by reducing other jobseekers' probability of finding one of the few available jobs. Both effects are captured by the positive and countercyclical wedge between micro-elasticity and macro-elasticity of unemployment with respect to net rewards from work. We derive a simple optimal unemployment insurance formula expressed in terms of those two elasticities and risk aversion. The formula coincides with the classical Baily-Chetty formula only when unemployment is low, and macro- and micro-elasticity are (almost) equal. The formula implies that the generosity of unemployment insurance should be countercyclical. We illustrate this result by simulating the optimal unemployment insurance over the business cycle in a dynamic stochastic general equilibrium model calibrated with US data.
Keywords: business cycle; unemployment insurance
JEL Codes: E24; E32; H21; H23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| job rationing during recessions (J68) | job search efforts do not significantly lower aggregate unemployment (J68) |
| generosity of unemployment insurance should be countercyclical (J65) | optimal replacement rate of unemployment benefits should increase during economic recessions (J68) |
| elasticity of unemployment (J64) | changes in unemployment insurance (J65) |
| optimal UI formula derived from model coincides with classical Baily-Chetty formula under low unemployment (J65) | importance of macroelasticity of unemployment (J64) |