Unemployment Benefits: Help or Hindrance?

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Almost 15 million Americans were jobless as of the end of 2010, a strikingly high 9.4 percent of the would-be working population. Although the mass layoffs that marked the beginning of the recession have tapered off, people who are out of work are having a hard time finding new jobs. A full 6.2 million of the unemployed have been that way for at least half a year. On average today, the unemployed stay out of work for a record-high 34 weeks, about 50 percent longer than in previous cycles.

As a consequence, more unemployed Americans than ever are tapping federal unemployment insurance (UI) benefits after exhausting state benefits. This situation has reignited a policy debate: Are overly generous benefits at least partly responsible for the rising unemployment rate?

The debate centers on two main arguments. One is that UI increases the nation’s unemployment rate and lengthens unemployment spells because job seekers put less effort into the search, a form of what economists term “moral hazard.” The other is that UI is not a significant factor in unemployment duration or rate, and something else is mainly responsible for the high numbers of both.

A New Deal

Signed into law by President Franklin Roosevelt in 1935 in response to the Great Depression, the Social Security Act provided the original framework of the unemployment insurance system. UI provides benefits for eligible workers who have lost their jobs involuntarily. Regular benefits are based on a percentage of an individual’s earnings over a recent 52-week period and are paid for a maximum of 26 weeks in most states.

Unemployment Benefits: A Disincentive to Job Seeking?

Harvard economist Robert Barro is one of the highest-profile critics of unemployment benefits. In a recent Wall Street Journal op-ed, he argued that in trying economic times, it is reasonable to adopt a more generous UI program—but not one that lasts almost two years. Unemployment benefits decrease efficiency, Barro and others argue, because the program subsidizes unemployment and can cause insufficient job search, job acceptance, and levels of employment. An unemployed person drawing benefits, for example, might search less vigorously for a job or be more selective about accepting offers than he would be in the absence of benefits.

Unemployment Benefits: An Economic Booster?

Some people may indeed take longer to find a new job because of unemployment insurance extensions, but many economists think that UI is not a large contributing factor in driving up the rate of unemployment or in lengthening its average duration.

Economists at the Federal Reserve Bank of San Francisco compared the duration of unemployment in four categories: involuntary job losers, voluntary job leavers, new labor market entrants, and re-entrants. Their goal was to find out whether there was a difference in length of unemployment between involuntary job losers (who are usually eligible for UI) and job leavers, new labor market entrants, and re-entrants (who usually are not). The results showed that involuntary job losers remain unemployed slightly longer than unemployed workers who are not eligible for benefits, indicating that extended UI benefits have a modest impact on unemployment duration.

The economists concluded that the impact of extended insurance benefits on the unemployment rate for all of 2009 and the first half of 2010 was about 0.8 percentage point. So, at the end of June 2010, the unemployment rate would have been 8.7 percent (compared with 9.5 percent if no UI program had been in place).

Another analysis looks at the broad economic effects of unemployment insurance. Federal Reserve Bank of Philadelphia senior economist Shigeru Fujita contends that the positive relationship between the level of benefits and the duration of unemployment is socially desirable. The benefits can improve unemployed people’s well-being, he says, by helping them avoid large drops in consumption in the face of job losses.

Since UI benefits increase the amount of cash the unemployed have, their consumption is supported, Fujita says, which improves the economy’s welfare. And when these workers continue to receive benefits, the pressure to accept a low-paying job is reduced. While this pattern initially seems counterproductive, it also may serve as motivation for creating higher-paying jobs in order to attract workers—another boost to the economy.

Moreover, UI cannot explain the doubling of the unemployment rate during the recession, even when an estimate of UI’s effect is on the high end. “I do believe that the effect on the unemployment rate is not more than 1 percentage point, probably less,” says Murat Tasci, an economist at the Federal Reserve Bank of Cleveland who specializes in business cycles and labor markets. “My conclusion is based on my observation that, for most of the period when extended unemployment insurance was in effect, job openings in the U.S. economy were at very depressed levels.” In other words, the unemployed couldn’t have gone off the rolls if they had wanted to—there was no work for them.

It’s logical that it would take some time for the unemployment rate to come down after a large shock like the one our nation recently experienced. Tasci’s view is in keeping with that of many other economists: that a large part of the unemployment rate increase results from the severe recession and the accompanying decline in output, not from extended benefits.

Timeline of the Emergency Unemployment Compensation Program (EUC08)

June 30, 2008
EUC08 program is introduced, with a 13-week maximum extension of benefits; set to expire March 28, 2009 (last day to file).
November 21, 2008
Maximum extension of benefits increased to 20 weeks; Tier II benefits introduced, providing up to an additional 13 weeks of benefits for those who worked in states with a total unemployment rate of at least 6 percent.
February 17, 2009
Expiration date extended to December 26, 2009; everyone receiving benefits under EUC08 to receive an additional $25 weekly benefit.
November 6, 2009
Tier II benefits extended to 14 weeks and no longer dependent on a state’s unemployment rate; Tier III (providing up to 13 more weeks to those in states with an average unemployment rate of 6 percent or higher) and Tier IV (providing up to an additional six weeks if the state unemployment rate is at least 8.5 percent) introduced.
December 19, 2009
Expiration date extended to February 28, 2010.
March 2, 2010
Expiration date extended to April 5, 2010.
April 15, 2010
Expiration date extended to June 2, 2010.
July 22, 2010
Expiration date extended to November 30, 2010.
December 6, 2010
Federal unemployment benefits extended and will remain in effect through the end of 2011 for workers who have been laid off for more than 26 and less than 99 weeks.
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Amy Koehnen

| Editorial Manager

Amy Koehnen

Amy Koehnen is the editorial manager in the Public Affairs Department at the Federal Reserve Bank of Cleveland. She also serves as editor of the Cleveland Fed’s policy publication, Forefront.

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