The effects of productivity and benefits on unemployment: Breaking the link

Alessio J. G. Brown, Britta Kohlbrecher, Christian Merkl & Dennis J. Snower

#2016-032

In the standard macroeconomic search and matching model of the labour market, there is a tight link between the effects of (i) productivity on unemployment and (ii) unemployment benefits on unemployment. This tight link is at odds with the empirical literature. We present a two-sided model of labour market search where the household and firm decisions are decomposed into job offers, job acceptances, firing, and quits. In such a model, unemploy-ment benefits affect households’ behaviour directly, without having to run via the bargained wage. In line with the evidence, productivity shocks may have quantitatively large effects on unemployment, while benefits only have moderate effects. Our analysis shows the importance of investigating the effects of policies on the households’ work incentives and the firms’ employment incentives within the search process.

Keywords: Unemployment benefits, search and matching, aggregate shocks, macro models of the labour market

JEL Classification: E24, E32, J63, J64