Discretionary Extensions to Unemployment-Insurance Compensation and Some Potential Costs for a McCall Worker

TL;DR

This paper models how discretionary extensions to unemployment benefits influence workers' reservation wages and labor supply decisions, highlighting potential costs and implications for policymakers during economic downturns and crises.

Contribution

It introduces a model analyzing the impact of discretionary benefit extensions on reservation wages and worker selectiveness, providing insights for policy interpretation and decision-making.

Findings

Extensions raise reservation wages and worker selectiveness.

Misperception of extension probability affects welfare outcomes.

Model aids policymakers in interpreting reservation wage data.

Abstract

Unemployment insurance provides temporary cash benefits to eligible unemployed workers. Benefits are sometimes extended by discretion during economic slumps. In a model that features temporary benefits and sequential job opportunities, a worker's reservation wages are studied when policymakers can make discretionary extensions to benefits. A worker's optimal labor-supply choice is characterized by a sequence of reservation wages that increases with weeks of remaining benefits. The possibility of an extension raises the entire sequence of reservation wages, meaning a worker is more selective when accepting job offers throughout their spell of unemployment. The welfare consequences of misperceiving the probability and length of an extension are investigated. Properties of the model can help policymakers interpret data on reservation wages, which may be important if extended benefits are used more often in response to economic slumps, virus pandemics, extreme heat, and natural disasters.