Abstract
Within a search and matching model with risk-averse workers, endogenous hiring and separation, and unobservable search effort, we show how to decentralize the constrained-efficient allocation by a combination of a production tax and three labor-market policy instruments: vacancy subsidies, layoff taxes, and unemployment benefits. We derive analytical expressions for the optimal mix of these over the business cycle. Calibrating the model to the US economy under the assumption that wages are rigid, we find that hiring subsidies and layoff taxes should rise considerably and persistently in recessions. The optimal variation in unemployment benefits, in contrast, is quantitatively small and short-lived. (JEL E24, E32, J24, J63, J64, J65)
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