This transfer component of unemployment insurance is particularly important because households that have been unemployed for more than a few months have often depleted many of their other resources to smooth their consumption in the face of unemployment, leaving them more likely to spend out of the transfer (Kekre 2016). Unemployment insurance is a transfer from employed workers to unemployed workers and the marginal propensity to consume seems to be larger for individuals experiencing a period of low income such as unemployment (Parker et al. By reducing the consumption impact of unemployment, a more generous unemployment insurance system mitigates this fall in aggregate demand. As a result, in a recession, the low consumption of unemployed individuals relative to the employed leads to a decline in aggregate consumption demand. When households become unemployed, they reduce their consumption sharply (e.g. Why does unemployment insurance stabilise the business cycle? On the other hand, the progressivity of the tax appears to have little effect on the business cycle.
We find that unemployment insurance has a substantial stabilising effect on the business cycle, and as a result the optimal policy is to have a more generous unemployment benefit than would be optimal in a world without macroeconomic fluctuations. We focus on two key programmes: a progressive tax system, and unemployment insurance. In a new paper, we investigate how the social insurance system affects the dynamics of the business cycle, and whether its stabilising effects call for a more or less generous social insurance system (McKay and Reis 2016a). But much less is known about how these policies stabilise the business cycle.
Automatic stabilizers act like how to#
There is a large literature on optimal social insurance systems, and how to balance the insurance value of insulating individuals from fluctuations in their market income against the incentive cost of reducing the return to work (Mirrlees 1971, Varian 1980, Baily 1978).
The social insurance system stands at the centre of automatic stabilisers, yet we still know too little about how it affects the macroeconomy (Blanchard et al. A remaining available option is the use of automatic fiscal stabilisers. Monetary policy may be running out of stimulative tools, and the political mood is against the use of discretionary fiscal stimulus. As the prospects of a recession in the near term have risen on both sides of the Atlantic in the wake of the Brexit referendum, there is a strong concern that traditional aggregate demand policies will not be available.
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