The elasticity of the unemployment rate with respect to benefits

doi:10.1016/j.econlet.2008.11.015

Economics Letters

Volume 102, Issue 2, February 2009, Pages 102-105

https://doi.org/10.1016/j.econlet.2008.11.015 Get rights and content

Abstract

Calibrated to replicate unemployment fluctuations, the standard Mortensen–Pissarides model implies that unemployment rises too strongly when benefits increase. Under an alternative bargaining assumption (right-to-manage) the model matches unemployment fluctuations, and implies a reasonable elasticity of unemployment with respect to benefits.

Introduction

By how much does the unemployment rate fall when unemployment insurance benefits are reduced? Calibrations of the textbook search and matching model that generate reasonably strong variations of unemployment over the business cycle, e.g. Hagedorn and Manovskii (2008), imply an unreasonably large drop of the unemployment rate when benefits are reduced; see Costain and Reiter (2008) and Mortensen and Nagypal (2007).

An alternative to the widely used efficient bargaining scheme (EB, henceforth), which follows Trigari's (2006) right-to-manage (RTM, henceforth) assumption, can also be calibrated to achieve sufficient unemployment fluctuations; see Christoffel and Kuester (2008).² The current paper shows that RTM, once calibrated to match fluctuations of unemployment over the business cycle, in contrast to EB implies a reasonable elasticity of the steady state unemployment rate to a change in benefits.

Section 2 presents the model. Section 3 describes the calibration. Section 4 reproduces Costain and Reiter's (2008) result that with EB one can either produce reasonable unemployment fluctuations or a reasonable semi-elasticity of unemployment with respect to benefits, but not both. In contrast, the section shows, the model with RTM can achieve both. Section 5 concludes.

Section snippets

The model

The model is a real-business-cycle version of Trigari (2006) with fixed costs in period profits.

Calibration

One time period in the model is 1 month. The model is calibrated to quarterly US data for the period 1984Q1 to 2006Q3. Output is nominal output in the business sector divided by the GDP deflator. The real wage (per hour) is the real compensation (per hour) in the business sector divided by the GDP deflator. Vacancies are the Conference Board's index of Help-Wanted Advertising. The civilian unemployment rate used is for the age group 16 years old and older.

Four variants of the model are

Results

Table 2 compares the implied second moments (relative to output) of the four model variants to their counterparts in the data. Without fixed costs, neither EB nor RTM is able to replicate the fluctuations in the labor market; see the cells formed by the third and fourth lines and second and fourth columns of Table 2. The third and fifth columns in turn show that both models are able to replicate these fluctuations once fixed costs are introduced. The introduction of fixed costs squeezes steady

Conclusions

This paper argued that a model with right-to-manage bargaining, i.e., a model in which the firm and the worker bargain only about hourly wages, and in which the firm retains the decision on the intensive (hours worked) margin, can be calibrated to quantitatively generate both realistic unemployment fluctuations over the business cycle and a realistic long-run response of unemployment levels to a change in the replacement rate, while the same is not true for a textbook model with efficient

References (6)

ChristoffelK. et al.
Resuscitating the wage channel in models with unemployment fluctuations
Journal of Monetary Economics
(2008)
CostainJ. et al.
Business cycles, unemployment insurance, and the calibration of matching models
Journal of Economic Dynamics and Control
(2008)
MortensenD. et al.
More on unemployment and vacancy fluctuations
Review of Economic Dynamics
(2007)

There are more references available in the full text version of this article.

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Other mechanisms have been proposed in the literature to break the link. Christoffel and Kuester (2009) propose a search and matching framework with a right-to-manage bargaining and fixed costs of production. While the latter is needed to generate sufficient amplification of productivity shocks, the former results in a more reasonable response to changes in unemployment benefits.5
In the standard macroeconomic search and matching model of the labor market, there is a tight link between the quantitative effects of (i) aggregate productivity shocks on unemployment and (ii) unemployment benefits on unemployment. This tight link is at odds with the empirical literature. We show that a two-sided model of labor market search where the household and firm decisions are decomposed into job offers, job acceptances, firing, and quits can break this link. In such a model, unemployment benefits affect households' behavior directly, without having to run via the bargained wage. A calibration of the model based on U.S. JOLTS data generates both a solid amplification of productivity shocks and a moderate effect of benefits on unemployment. Our analysis shows the importance of investigating the effects of policies on the households' work incentives and the firms' employment incentives within the search process.
Efficiency in a search and matching model with right-to-manage bargaining
2012, Economics Letters
In a search and matching model with right-to-manage bargaining, matched workers and firms bargain over wages, given the firm’s demand schedule for hours per worker. Wages and hours per worker are determined as if they are determined in a competitive labor market with a distortion to wage markups. A positive inefficiency gap in the labor market diminishes workers’ effective bargaining power relative to firms, because firms can adjust labor input and wage schedule via the intensive margin. The Hosios condition does not necessarily hold even when workers’ actual bargaining power is equal to the unemployment elasticity of matches.
Labor Productivity, Effort and the Euro Area Business Cycle
2019, SSRN
Tracking labor demand with online job postings: The case of health IT workers and the HITECH act
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^☆: The views expressed in this paper are those of the authors. They do not necessarily coincide with those of the European Central Bank, or the Federal Reserve Bank of Philadelphia or the Federal Reserve System.

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