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Unemployment Insurance In Macroeconomic Stabilization

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Abstract:
I study unemployment insurance (UI) as a discretionary policy instrument in an environment with incomplete markets, search frictions, and nominal rigidities.  An increase in generosity can be expansionary if the unemployed have a higher marginal propensity to consume (MPC) or agents precautionary save in light of future income risk.  The resulting aggregate demand externality motivates optimally higher generosity if the economy is inefficiently slack.  Calibrated to the U.S. economy in an environment like the Great Recession, UI benefit extensions raise employment and utilitarian social welfare through these channels.  Primitives governing MPC heterogeneity and precautionary saving, such as the cross-sectional incidence of unemployment and agents' degree of prudence, are at least as important as search and wage responses in determining the macroeconomic effects of temporary changes in UI.