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
Full paper (138 KB PDF)
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Last update: February 13, 2003
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