DP2126 Equilibrium Unemployment Insurance

Author(s): John Hassler , José Vicente Rodríguez Mora , Kjetil Storesletten , Fabrizio Zilibotti

Publication Date: April 1999

Keyword(s): Comparative Advantage , Employment , Political Equilibrium , Search , Specialization , Unemployment Insurance

JEL(s): D72 , E24 , J24 , J64 , J65

Programme Areas: International Macroeconomics , Labour Economics

Link to this Page: www.cepr.org/pubs/dps/DP2126.asp

In this paper, we incorporate a positive theory of unemployment insurance into a dynamic overlapping generations model with search-matching frictions and on-the-job learning-by-doing. The model shows that societies populated by identical rational agents, but differing in the initial distribution of human capital across agents, may choose very different unemployment insurance levels in a politico-economic equilibrium. The interaction between the political decision about the level of the unemployment insurance and the optimal search behavior of the unemployed gives rise to a self-reinforcing mechanism which may generate multiple steady-state equilibria. In particular, a European-type steady-state with high unemployment, low employment turnover and high insurance can co-exist with an American-type steady-state with low unemployment, high employment turnover and low unemployment insurance. A calibrated version of the model features two distinct steady-state equilibria with unemployment levels and duration rates resembling those of the U.S. and Europe, respectively.