A Macroeconomic Approach to Optimal Unemployment Insurance: Theory
- American Economic Journal: Economic Policy (Forthcoming)
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
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