A Macroeconomic Approach to Optimal Unemployment Insurance: Applications
- American Economic Journal: Economic Policy (Forthcoming)
In the United States, unemployment insurance (UI) is more generous when unemployment
is high. This paper examines whether this policy is desirable. The optimal UI replacement rate
is the Baily-Chetty replacement rate plus a correction term measuring the effect of UI on welfare
through labor market tightness. Empirical evidence suggests that tightness is inefficiently
low in slumps and inefficiently high in booms, and that an increase in UI raises tightness.
Hence, the correction term is positive in slumps but negative in booms, and optimal UI is indeed
countercyclical. Since there remains some uncertainty about the empirical evidence, the
paper provides a thorough sensitivity analysis.
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