Optimal Unemployment Insurance

We investigate the design of an optimal Unemployment Insurance program using an equilibrium search and matching model calibrated using data from the reemployment bonus experiments and secondary sources. We examine (a) the optimal potential duration of UI benefits, (b) the optimal UI replacement rate when the potential duration of benefits is optimal, and (c) the optimal UI replacement rate when the potential duration of benefits is sub-optimal. There are three main conclusions. First, insurance considerations suggest that the potential duration of UI benefits would be unlimited under an optimal program. Hence, existing UI programs in the U.S. provide benefits for too short a period of time. Second, if the potential duration to benefits were unlimited, current replacement rates in the U.S., which are in the neighborhood of .5, would probably be about right. Third, with the potential duration of benefits limited to 26 weeks, as in most states during normal times, replacement rates of .5 are too low -the optimal replacement rate is 1 if the potential duration of benefits is limited to 32 weeks or less.