Search frictions, real wage rigidities and the optimal design of unemployment insurance

In this paper, we study the optimal unemployment benefits financing scheme when the economy is subject to labor market imperfections characterized by real wage rigidities and search frictions. The US unemployment insurance financing is such that firms are taxed proportionately to their layoffs to fi...

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Bibliographic Details
Published in:Journal of economic dynamics & control 2013-09, Vol.37 (9), p.1796-1813
Main Authors: Albertini, Julien, Fairise, Xavier
Format: Article
Language:English
Subjects:
DSGE models
Economic theory
Labor economics
Labor market
Labour market
Layoff tax
Pareto efficiency
Pareto optimum
Quantitative Finance
Real wages
Search and matching frictions
Social policy
Studies
Unemployment
Unemployment benefits
Unemployment insurance
Wage rigidities
Welfare costs
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Summary:In this paper, we study the optimal unemployment benefits financing scheme when the economy is subject to labor market imperfections characterized by real wage rigidities and search frictions. The US unemployment insurance financing is such that firms are taxed proportionately to their layoffs to finance unemployment benefits. Using DSGE methodology, we investigate how policy instruments should interact with labor market imperfections. It is shown that wage rigidities in a search and matching environment cause welfare costs, especially in the absence of an incentive-based unemployment insurance. This cost is mainly due to the distorting effect of wage rigidities which generate inefficient separations. We show that the optimal unemployment benefits financing scheme – corresponding to the Ramsey policy – offsets labor market imperfections and allows implementation of the Pareto allocation. The second-best allocation brings the economy close to the Ramsey allocation. The implementation of the optimal policies clearly highlights the role of labor market institutions for short-run stabilization.
ISSN:0165-1889
1879-1743
DOI:10.1016/j.jedc.2013.03.010