Will extension of unemployment benefits help or hurt the economy

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Will Extension of Unemployment Benefits

Help or Hurt the Economy?Post prepared July 23 2010

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Post P100723 from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/

Extending Unemployment Benefits

On July 22, 2010, President Obama signed a bill extending unemployment benefits from the usual 26 weeks to 99 weeks

Benefits average around $300 per week

Questions:Why were benefits extended?What will be the effects on the

job market?On balance, will the extension

help or hurt the economy?

We are . . . providing immediate assistance to people who are out there looking for work. But ultimately, our goal is to make sure the people who are looking for a job can find a job. www.whitehouse.gov. Picture and statement on economy, July 22, 2010

http://www.whitehouse.gov/


Duration of Unemployment

An unusually high number of long-term unemployed is one reason for the push to extend unemployment benefits

In normal times, relatively few unemployed workers are out of work for 26 weeks or longer, for example, just 16% of at the end of 2006

By mid-2010, the percentage of long-term unemployed had risen to 45% of all unemployed workers


Long-term Unemployment: Historical Comparison

Recessions shown by gray bars

Long-term unemployment always rises during and just after a recession, but the increase during the latest recession has been by far the highest for the past 60 years


Unemployment Extension as Social Policy

Extension of unemployment benefits is considered by many to be a social policy priority because unemployment disproportionately affects low-income households

Education also matters. Some selected unemployment rates: No High-school degree: 14.6% High-school only: 9.7% Associate degree: 6.8% Bachelor’s degree: 5.2%


Job Market Effects: Duration of Unemployment

By definition, an unemployed worker must be searching for work. Those not working or looking for work are not usually counted in the labor force

Unemployment benefits lower the opportunity cost of job search

International comparisons suggest that increasing either the duration of unemployment benefits or the replacement ratio tends to increase unemployment, especially long-term unemployment

Vertical scale shows ratio of benefit to previous wage in first year of unemployment. Horizontal scale is artificial; higher number shows longer duration, but not measured in years. Number in box shows percentage of long-term unemployed among all unemployed. Data source: OECD

Basic Job Search Model

At the beginning of job search, worker sets a reservation wage—the lowest wage at which a job will be accepted

Possible jobs are discovered sequentially and at random Worker accepts first job that meets or exceeds reservation wage Reservation wage will decrease over time as savings are used up and new information

makes ideas about available jobs more realistic


Effect of Reservation Wage on Unemployment

Worker 1 with higher reservation wage schedule R1 searches longer than worker 2 with reservation wage schedule R2

Implication: A higher reservation wage means longer average duration of unemployment, and therefore a higher average unemployment rate


Effects of Unemployment Benefits on Job Search

Unemployment benefits paid for D weeks raise the reservation wage schedule from R1 to R2, causing worker to continue searching longer than without benefits

Reservation wage begins to drop rapidly after benefits expire as savings are used up and opportunity cost of search rises

Implication: Higher or longer benefits raise average duration and rate of unemployment



Do Benefits Help or Harm the Job Market?

By itself, a longer period out of work before finding a job is good for the labor market

However, by allowing workers to search more carefully, unemployment benefits may result in better matching of workers to jobs, thereby improving labor market efficiency

For that reason, governments usually provide job information, training, and incentives to search along with unemployment payments

Photo source: http://commons.wikimedia.org/wiki/File:FEMA_-_29783_-_Workers_unemployed_by_the_freeze_in_California.jpg


Macroeconomic Effects

In the short run, unemployment benefits support consumer spending by unemployed workersConsumer spending helps boost

aggregate demandOther things being equal, that can

speed recovery from recession On the down side, higher

unemployment benefits complicate the essential long-term task of controlling the government’s debt and deficit


The Bottom Line

Extension of benefits will help some of the neediest of the unemployed

Extended benefits will likely slow any drop in long-term unemployment

Lower opportunity cost of job search may help match workers to jobs

Extension of benefits will have a positive short-term stimulus effect

The added cost of extended benefits will complicate the long-term job of controlling the deficit an debt

Testifying before Congress on July 22, Fed Chairman Ben Bernanke called unemployment “our most important problem” and favored maintaining moderate fiscal stimulus for the time being

Will extension of unemployment benefits help or hurt the economy

Education

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