Extensions Of Unemployment Benefits Increased Equilibrium Wage, Decreased Job Creation And Caused Persistent Increase In Unemployment: Macro Effects Research

From NBER Working Paper Series, "Unemployment Benefits and Unemployment in the Great Recession: The Role of Macro Effects" by Marcus Hagedorn, Fatih Karahan, Iourii Manovskii, and Kurt Mitman, NBER Working Paper No. 19499, October 2013:

ABSTRACT
We exploit a policy discontinuity at U.S. state borders to identify the effects of unemployment insurance policies on unemployment. Our estimates imply that most of the persistent increase in unemployment during the Great Recession can be accounted for by the unprecedented extensions of unemployment benefit eligibility. In contrast to the existing recent literature that mainly focused on estimating the effects of benefit duration on job search and acceptance strategies of the unemployed -- the micro effect -- we focus on measuring the general equilibrium macro effect that operates primarily through the response of job creation to unemployment benefit extensions. We find that it is the latter effect that is very important quantitatively. [Emphasis Added.]

PAPER
5 The Role of Macro Effects

In equilibrium labor market search models, the dynamics of unemployment over the business cycle and the response of unemployment to changes in policies are primarily driven by employers’ vacancy creation decisions. Consider, for example, an increase in unemployment benefit duration. Having access to longer spells of benefits improves the outside option of workers and leads to an increase in the equilibrium wage. This lowers the accounting profits of firms and reduces vacancy posting to restore the equilibrium relationship between the cost of firm entry and the expected profits. Lower vacancy creation leads to a decline in labor market tightness, defined as the ratio of vacancies to unemployment. This lowers the job finding rate of workers and results in an increase in unemployment.

In this section, we present evidence on the empirical relevance of these macro effects. In particular, we document the effect of unemployment benefit extensions on vacancy creation, employment, and wages in the data.***8 Conclusion

In this paper we employed a state-of-the-art empirical methodology to measure the total effect of unemployment benefit extensions on unemployment. In particular, we exploited the discontinuity of unemployment insurance policies at state borders to identify their impact. Our estimator controls for the effect of expectations of future changes in benefits and has a simple economic interpretation. It is also robust to the heterogeneous impacts of aggregate shocks on local labor markets.

We found that unemployment benefit extensions have a large effect on total unemployment. In particular, our estimates imply that unemployment benefit extensions can account for most of the persistently high unemployment after the Great Recession. [Emphasis Added.]