Abstract

Beside the function of insuring workers against the risk of unemployment, unemployment benefits might also be used as a Pigouvian instrument. When the magnitude of distorted aggregate search depends on the state of the economy along the business cycle, unemployment benefits optimally have to vary over the cycle too, even if workers are risk-neutral. The paper presents a search and matching model that explicitly allows for non-constant returns to scale in matching which generate this type of externalities. It is shown that without policy intervention a generalized Hosios condition guaranteeing constrained efficiency cannot hold for any state of the economy. The implementation of the optimal allocation involves pro-cyclical (counter-cyclical) benefits correcting for excessive (too little) aggregate search activity if the matching function exhibits decreasing (increasing) returns to scale. Numerical simulations suggest that the cycle-dependent Pigouvian role of benefits is quantitatively rather limited compared to the classical function of insurance provision. This conclusion, however, is directly related to the Shimer-puzzle and the implausibly low responsiveness of the match surplus to productivity shocks for this class of models.

Draft