This paper develops a theory of optimal unemployment insurance (UI) in matching models. The optimal UI replacement rate is the conventional Baily-Chetty replacement rate, which solves the tradeoff between insurance and job-search incentives, plus a correction term, which is positive when an increase in UI pushes the labor market tightness toward its efficient level. In matching models, most wage mechanisms do not ensure efficiency, so tightness is generally inefficient. The effect of UI on tightness depends on the model: increasing UI may raise tightness by alleviating the rat race for jobs or lower tightness by increasing wages through bargaining.
"A Macroeconomic Approach to Optimal Unemployment Insurance: Theory."
American Economic Journal: Economic Policy,
Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Time Allocation and Labor Supply
Wage Level and Structure; Wage Differentials
Unemployment: Models, Duration, Incidence, and Job Search
Unemployment Insurance; Severance Pay; Plant Closings