In the United States, unemployment insurance (UI) is more generous when unemployment is high. This paper examines whether this policy is desirable. The optimal UI replacement rate is the Baily-Chetty replacement rate plus a correction term measuring the effect of UI on welfare through labor market tightness. Empirical evidence suggests that tightness is inefficiently low in slumps and inefficiently high in booms, and that an increase in UI raises tightness. Hence, the correction term is positive in slumps but negative in booms, and optimal UI is indeed countercyclical. Since there remains some uncertainty about the empirical evidence, the paper provides a thorough sensitivity analysis.

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1 May 2018

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American Economic Journal: Economic Policy 10(2) , pp.182-216, 2018

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DOI: 10.1257/pol.20160462

https://pubs.aeaweb.org/doi/10.1257/pol.20160462

This Journal article is published under the centre's Labour programme.