A Quantitative Theory of Time-Consistent Unemployment Insurance
Yun Pei and Zoe Xie
Working Paper 2016-11
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During recessions, the U.S. government substantially increases the duration of unemployment insurance (UI) benefits through multiple extensions. This paper seeks to understand the incentives driving these increases. Because of the trade-off between insurance and job search incentives, the classic time-inconsistency problem arises. This paper endogenizes a time-consistent UI policy in a stochastic equilibrium search model, where a government without commitment to future policies chooses the UI benefit level and expected duration each period. A longer benefit duration increases unemployed workers’ consumption but reduces job search, leading to higher future unemployment. Quantitatively, the model rationalizes most of the variations in benefit duration during the Great Recession. We use the framework to evaluate the effects of the 2009–13 benefit extensions on unemployment and welfare.
JEL classification: E61, J64, J65, H21
Key words: time-consistent policy, unemployment insurance, labor market, business cycle