A Quantitative Theory of Time-Consistent Unemployment Insurance
Yun Pei and Zoe Xie
Working Paper 2016-11a
Revised December 2017
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 extensions. Because of the trade-off between insurance and job search incentives, the classic time-inconsistency problem arises. We endogenize 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 duration increases the unemployed workers’ consumption but reduces their job search incentives, leading to higher future unemployment. We use the framework to evaluate the effects of the 2008-2013 benefit extensions on unemployment and welfare.
JEL classification: E61, J64, J65, H21
Key words: time-consistent policy, unemployment insurance, labor market, business cycle