Designing a Cheaper and More Effective Unemployment Benefit System

This paper describes an equilibrium labour market in which an unemployment benefit system cannot raise the average value of being unemployed in the long run. It proposes an alternative benefit system which pays generous benefit rates when unemployment is high, but pays much lower rates in booms. By targeting unemployment compensation to recessions, when being unemployed is particularly costly, this policy provides insurance equivalent to that provided by the current system. By reducing the value of remaining unemployed in booms, the benefit reduction increases wage flexibility over the cycle, which substantially reduces average unemployment.