State Dependent Unemployment Benefits

State Dependent Unemployment Benefits

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Article ID: iaor201112121
Volume: 78
Issue: 2
Start Page Number: 325
End Page Number: 344
Publication Date: Jun 2011
Journal: Journal of Risk and Insurance
Authors: ,
Keywords: insurance, unemployment
Abstract:

Optimal design of unemployment insurance is considered in a search setting where the state of nature (business cycle) affects the unemployment risk and thus the return to search. The incentive effects or distortions of individual job search arising due to the unemployment insurance scheme are crucial for optimal policies, so is the scope for risk diversification that depends critically on whether the balanced budget requirement applies to each state of nature or across states of nature. In the former case a basic budget effect tends to cause optimal benefits to be procyclical. If risk diversification across states of nature is possible, the fact that incentives are more distorted in good than bad states of nature tends to make both benefits and contribution rates countercyclical. It is shown that countercyclical benefits exacerbate employment fluctuations but increase average employment by aligning benefits more with states of nature where the incentive costs are small.

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