DP15748 Whether, When and How to Extend Unemployment Benefits: Theory and Application to COVID-19

Author(s): Kurt Mitman, Stanislav Rabinovich
Publication Date: February 2021
Keyword(s): Markov perfect equilibrium, optimal policy, Unemployment insurance
JEL(s): E6, H1, J65
Programme Areas: Labour Economics, Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15748

We investigate the optimal response of unemployment insurance to economic shocks, both with and without commitment. The optimal policy with commitment follows a modified Baily-Chetty formula that accounts for job search responses to future UI benefit changes. As a result, the optimal policy with commitment tends to front-load UI, unlike the optimal discretionary policy. In response to shocks intended to mimic those that induced the COVID-19 recession, we find that a large and transitory increase in UI is optimal; and that a policy rule contingent on the change in unemployment, rather than its level, is a good approximation to the optimal policy.