Pro-Cyclical Unemployment Benefits? Optimal Policy in an Equilibrium Business Cycle Model

Abstract

We study the optimal provision of unemployment insurance (UI) over the business cycle. We use an equilibrium Pissarides search and matching model with aggregate shocks to labor productivity, augmented to incorporate risk-averse workers, endogenous worker search eort decisions, and unemployment benet expiration. Both the vacancy creation decisions of rms and the search effort decisions of workers respond to changes in UI policy. Our calibrated model is consistent with aggregate US data on labor market volatility, as well as with micro studies on the responsiveness of unemployment duration to benet generosity. We use the model to characterize the optimal UI policy, allowing both the benet level and benet duration to depend on the history of past aggregate shocks. We nd that, all else equal, the optimal benet