Extended Unemployment Benefits Explain High Unemployment Rates

by: Calafia Beach Pundit

I've featured this chart many times in recent years, always commenting to the effect that the decline in the number of people receiving unemployment insurance benefits was good news for the economy since it increased the incentives of the unemployed to find and accept jobs. Recall that Congress in 2008 took the unprecedented step of creating emergency unemployment benefits, which had the effect of significantly boosting the number and duration of people receiving benefits. Until the Great Recession, we had never seen such a high level of unemployed receiving benefits for so long, so it is very tempting to link that with the fact that the unemployment rate has been exceptionally high in recent years.

As this paper points out, however, I may have missed the more important impact of extended unemployment benefits. Extended unemployment benefits keep worker's salary expectations high, and that has the effect of reducing employers' willingness to hire. It's not that unemployed individuals are insufficiently motivated to find work, it's that employers are insufficiently motivated to seek out more workers since salary expectations remain high.

... our estimates imply that most of the persistent increase in unemployment during the Great Recession can be accounted for by the unprecedented extensions of unemployment benefit eligibility.

... extending unemployment benefits exerts an upward pressure on the equilibrium wage. This lowers the profits employer receive from the filled jobs. As in equilibrium expected profits from filled jobs are driven down to the cost of vacancy posting, vacancy posting has to decline. Lower vacancies imply a lower job finding rate for workers, which leads to an increase in unemployment.

In any case, the ongoing and significant decline in the number of people receiving unemployment benefits (down 21% in the past 12 months) is a good reason to remain optimistic about the economy's ability to expand total employment.