What Are the Pros and Cons of Unemployment Benefits?

Monday, January 26, 2015

Each issue of The Regional Economist, published by the Federal Reserve Bank of St. Louis, features the section “Ask an Economist,” in which one of the Bank’s economists answers a question. The answer below was provided by Senior Economist Juan Sanchez.

In short, the answer is insurance and incentives.

Unemployment insurance benefits help individuals who have lost their job to sustain a desirable consumption level. An MIT economist, Jonathan Gruber, argues that private insurance or savings are not enough to prevent a large drop in the consumption of the unemployed. In particular, he estimated that in the absence of unemployment insurance, the consumption of the unemployed would fall by 22 percent. This drop would be more than three times the average fall in the presence of this program.1

Perhaps the most important disadvantage is that unemployed individuals may be discouraged from searching for a job (or taking certain jobs) if unemployment benefits are too generous. Alan Krueger from Princeton University and Andreas Mueller from the Institute for International Economic Studies at Stockholm University found that across the 50 states and District of Columbia, job searches are inversely related to the generosity of unemployment benefits. In particular, the time devoted to job search drops by about 16 percent when unemployment benefits increase by 10 percent. The two economists also found that job search intensity increases prior to the exhaustion of benefits.2

The current programs in the U.S. and in most of the developed countries involve two or three levels of benefits that often decrease over the unemployment spell; the benefits are provided for a restricted period of time. This design resembles prescriptions in the seminal work of the economists Hugo Hopenhayn from UCLA and Juan Pablo Nicolini from the Federal Reserve Bank of Minneapolis and Universidad Torcuato Di Tella in Buenos Aires. They found that the best way to design an unemployment insurance program involves payments that decrease throughout the unemployment spell. They also prescribe a tax on each individual after re-employment—a tax that increases with the length of the previous unemployment spell.3 The entire program can be implemented with unemployment insurance accounts for each individual. Individuals who use their benefits for a longer period of time would have to contribute more after re-employment to balance their account.

Notes and References

1 Gruber, Jonathan. "The Consumption Smoothing Benefits of Unemployment Insurance," The American Economic Review, Vol. 87, No. 1, March 1997, pp. 192-205.

2 Krueger, Alan; and Mueller, Andreas. "Job Search and Unemployment Insurance: New Evidence from Time Use Data," Journal of Public Economics, Vol. 94, No. 3-4, April 2010, pp. 298-307.

3 Hopenhayn, Hugo A.; and Nicolini, Juan Pablo. "Optimal Unemployment Insurance," Journal of Political Economy, Vol. 105, No. 2, April 1997, pp. 412-38.

Additional Resources

Posted In Labor  |  Tagged juan sanchezunemploymentunemployment benefits
Commenting Policy: We encourage comments and discussions on our posts, even those that disagree with conclusions, if they are done in a respectful and courteous manner. All comments posted to our blog go through a moderator, so they won't appear immediately after being submitted. We reserve the right to remove or not publish inappropriate comments. This includes, but is not limited to, comments that are:
  • Vulgar, obscene, profane or otherwise disrespectful or discourteous
  • For commercial use, including spam
  • Threatening, harassing or constituting personal attacks
  • Violating copyright or otherwise infringing on third-party rights
  • Off-topic or significantly political
The St. Louis Fed will only respond to comments if we are clarifying a point. Comments are limited to 1,500 characters, so please edit your thinking before posting. While you will retain all of your ownership rights in any comment you submit, posting comments means you grant the St. Louis Fed the royalty-free right, in perpetuity, to use, reproduce, distribute, alter and/or display them, and the St. Louis Fed will be free to use any ideas, concepts, artwork, inventions, developments, suggestions or techniques embodied in your comments for any purpose whatsoever, with or without attribution, and without compensation to you. You will also waive all moral rights you may have in any comment you submit.
comments powered by Disqus

The St. Louis Fed uses Disqus software for the comment functionality on this blog. You can read the Disqus privacy policy. Disqus uses cookies and third party cookies. To learn more about these cookies and how to disable them, please see this article.

Subscribe to
On the Economy

Get notified when new content is available on our On the Economy blog.

Email Alerts  |  RSS

About the Blog

The St. Louis Fed On the Economy blog features relevant commentary, analysis, research and data from our economists and other St. Louis Fed experts.

Views expressed are not necessarily those of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.

Contact Us

For media-related questions, email mediainquiries@stls.frb.org. For all other blog-related questions or comments, email on-the-economy@stls.frb.org.