Unemployment dynamics and endogenous unemployment insurance extensions

Abstract

This paper investigates the general equilibrium effects of endogenous unemployment insurance (UI) extensions on the dynamics of unemployment and its duration in the US. Using a stochastic random-search-and-matching model with worker heterogeneity, I allow for the maximum UI duration to endogenously depend on unemployment, and for UI benefits to depend on worker characteristics replicating the US benefit system. The model is able to generate the observed incidence of (long-term) unemployment over the past six decades. Responses of job search to UI extensions (microeconomic effect of UI) are important for both long-term and total unemployment whilst responses of job separations (general equilibrium effect of UI) is important for total unemployment. Worker heterogeneity in terms of benefit levels is crucial for the unemployment duration dynamics via heterogeneous job finding rates. Disregarding the rational expectations of UI extensions may overestimate unemployment by almost 2 percentage points.