Discussion paper

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

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.

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Citation

Mitman, K and S Rabinovich (eds) (2021), “DP15748 Whether, When and How to Extend Unemployment Benefits: Theory and Application to COVID-19”, CEPR Press Discussion Paper No. 15748. https://cepr.org/publications/dp15748