Unemployment insurance and labour productivity over the business cycle

Abstract

This paper quantifies the effects of the increasing maximum unemployment insurance (UI) duration during recessions on the drop in the correlation between output and labour productivity in the U.S. since the early 1980s – the so-called productivity puzzle. Using a general equilibrium search and matching model with stochastic UI duration, heterogeneous match quality, variable search intensity and on-the-job search, I demonstrate that the model can explain over 40 percent of the drop in this correlation (28 percent when the Great Moderation is taken into account). More generous UI extensions during recent recessions cause workers to be more selective with job offers and lower job search effort. The former channel raises the overall productivity in bad times. The latter prolongs UI extensions since in the U.S. they are triggered by high unemployment.