|Copyright:||(c) 2011 Federal Reserve Bank of Chicago|
During recessions, it is common for the federal government to extend the standard unemployment insurance (UI) program. Many economic studies have shown that workers who receive UI extensions tend to take longer to find new employment, leading to a somewhat longer average duration of unemployment among all workers.
(ProQuest: … denotes formula omitted.)
The passage and creation of the Emergency Unemployment Compensation (EUC) federal program in
Providing monetary assistance to the unemployed for longer periods may benefit individuals and the aggregate economy, at least in the short run. However, there is some concern that UI extensions might also provide a disincentive for working. Some recent research suggests that longer spells of UI receipt are actually welfare enhancing for many individuals who have low levels of savings and who might otherwise be forced to take jobs that represent poor matches for their skill levels.2 In any event, whether beneficial or not, longer spells of unemployment arising from UI extensions will automatically lead to higher rates of unemployment. Since policymakers place a great deal of weight on the unemployment rate as a measure of the degree of slack in the economy when formulating macroeconomic policy, it is important for us to understand how much of the recent rise in the unemployment rate may be due to UI extensions.
In this Chicago Fed Letter, I present new estimates of the extent to which the EUC program may have contributed to the rise in the unemployment rate during the recent recession and early recoverv period. I use a simulation that applies to the current episode an estimate from the literature of the effects of UI extensions on the duration of unemployment. First, I review some other studies on the topic.
Research on the EUC program
The key challenge for researchers studying the effects of UI extensions on unemployment is distinguishing cause from effect because extensions are typically enacted in response to poor economic conditions that lead to rising unemployment. Therefore, researchers must use an identification strategy to either control for economic conditions or to create a suitable comparison group.
Fujita5 identifies the effects of the UI extensions by comparing the unemployment durations of men in the CPS who were unemployed in 2004-07 with the durations of men who were unemployed in 2009-10. He finds that extensions account for between 0.9 and 1.7 percentage points of the change in the steady-state unemployment rate for men.6 By using the “pre” and “post” EUC program differences, the study provides a nice complement to
In an earlier paper, Fujita7 uses a simpler model of the unemployment rate and takes an estimate from the literature on the effects of UI extensions on the duration of unemployment to produce an estimate of the effect of the EUC program. He finds that the recent UI extensions may account for about 1.5 percentage points of the increase in the unemployment rate. A nice feature of this study is that it provides a useful theoretical framework that uses the flows into and out of unemployment to derive the steady-state unemployment rate. However, the approach implicitly assumes that «//unemployed workers are covered by UI and it only considers extensions from 25 to 52 weeks, even though many workers can potentially collect UI for up to 99 weeks. The study also relies on an estimate based on data from several states during the 1970s and 1980s.8 This could be problematic because the UI extensions during that period reflected responses to high unemployment, thereby possibly confusing cause and effect as described earlier.9
Finally, Aaronson, Mazumder, and Schechter10 use a range of estimates from the literature on the effect of UI extensions on unemployment duration and apply them to argue that the recent UI extensions accounted for between 10% and 25% of the increase in observed unemployment durations between
Base case estimates
My approach starts with the framework of the steady-state unemployment rate used by
where s is the rate at which employed workers “separate” into unemployment, f is the rate at which unemployed workers “find” employment, and U is the unemployment rate.11 1 start by taking advantage of two key facts that characterized the labor market in the six months prior to the increase in UI extensions (January to
I then estimate how /changes as a result of the UI extensions. I use Card and Levine’s14 estimate that a 1-week increase in the maximum potential duration of receipt of UI leads to a 0.1-week increase in the duration of unemployment. To define the increase in the maximum potential period of UI receipt, I follow Aaronson, Mazumder, and Schechter (2010) and use the triggers relevant for each state for each month to calculate a time series of the nationally weighted average of the maximum potential duration of UI receipt. As of Februar)’ 2011, this stood at about 95 weeks. Therefore, the change in potential duration of UI receipt is 69 weeks.15 1 assume that the take-up rate of UI among the unemployed is 40%, which was the coverage rate prior to the UI extensions in
In combination, these assumptions imply that unemployment durations would increase from 17 weeks to 19.8 weeks with the extension of UI benefits.16 This implies that /would fall to 0.22. Using the equation above, the steady-state rate of unemployment would be 5.9%, or a 0.8 percentage point increase in steadystate unemployment due to UI extensions. It is worth noting that this may be a conservative estimate for the size of effect going forward. If the unemployment rate declines over the next year, as it is projected to do, the maximum duration of benefits will also decline, because many states will no longer set off the triggers that lead to automatic benefit extensions.
Card and Levine’s (2000) estimate of the effect of UI on unemployment duration is based on an extension of UI benefits in
My baseline estimates assume a UI takeup rate of 40%. This was the take-up rate at the time that the extensions were implemented; since then, however, the take-up rate has risen to close to 70%. In unpublished work, my colleague
In summary, the base case and alternative estimates using the approach outlined in this article suggest that the extension of unemployment insurance benefits during the recent economic downturn can account for somewhere in the neighborhood of 1 percentage point of the increase in the unemployment rate, with a preferred estimate of 0.8 percentage points. One should keep in mind that this effect is also likely to be reversed over the coming years, as the extensions are removed in response to an improving labor market.
It is important for us to understand how much of the recent rise in the unemployment rate may be due to Ul extensions.
The extension of unemployment insurance benefits during the recent economic downturn can account for approximately 1 percentage point of the increase in the unemployment rate, with a preferred estimate of 0.8 percentage points.
1 This is a weighted average across all states where the weights correspond to the state share of the total number of unemployed individuals.
2 See Raj Chetty, 2008, “Moral hazard versus liquidity and optimal unemployment insurance, ”
3 See Rob Valletta and
4 For example, suppose those who quit their jobs or enter the labor force (and, thus, are ineligible for UI) are, on average, higherquality workers than those who are laid off (and, thus, eligible for UI) . Then the quitters/ new entrants would have shorter spells of unemployment, regardless of the effects of UI on the unemployment spells of the eligible workers.
5 See Shigeru Fujita, 2011, “Effects of extended unemployment insurance benefits: Evidence from the monthly CPS,”
6 The steady- state unemployment rate refers to a period in which economic conditions are relatively stable, so that the key variables that determine the unemployment are at their average values.
7 See Shigeru Fujita, 2010, “Economic effects of the unemployment insurance benefit,” Business Reviexu, Fourth Quarter,
9 In addition, during that period it was far more common for firms to use temporary layoffs and to time the recall dates to coincide with the time limits on UI receipt. Therefore, using estimates of the effects of UI extensions from this period may lead to overestimation of the effects for the current period (see
10 See Daniel Aaronson, Bhashkar Mazumder, and
11 This formula can be derived by starting with a simple model of the evolution of the unemployment rate. The unemployment rate in the current period is equal to the unemployment rate in the previous period, plus the fraction of the employed who separate, minus the fraction of the unemployed who find work: ut = ut-1 + sE-fut-1, which implies that in the steady state, uss = uss + s(1 – uss) – fuss. Solving; for uss yields uss = s/ (s+ f).
12 An estimate of the job-finding probability in a week is given by 1/17. I convert this to a monthly probability by multiplying it by 4.3 (the average number of weeks in a month). An implicit assumption is that s does not change. In addition, ideally, one would want to use data on completed spells rather than ongoing spells. Using estimates of completed spells from
13 The value forfis very close to empirical estimates of the U to F (unemployment to employment) transition rates for the January to
14 See David Card and
15 This is the 95 weeks, minus the 26 weeks available to workers prior to the UI extensions.
16 This is the result of multiplying 69 weeks by the 0.1 elasticity and scaling this down by the 0.4 coverage rate. This 2.8 effect on weeks is added back to the 17-week duration prevailing at the time of the UI extension.
17 See Lawrence F. Katz and
18 If we use the Katz and Meyer (1990) estimate and also assume that the UI extensions increased the take-up rate to 55%, this would imply that the UI extensions led to a 1.7 percentage point increase.
by Bhashkar Mazumder, senior economist and director,