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Murat Tasci |

Research Economist

Murat Tasci

Murat Tasci is a research economist in the Research Department of the Federal Reserve Bank of Cleveland. He is primarily interested in macroeconomics and labor economics. His current work focuses on business cycles and labor markets, labor market policies, and search frictions.

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Mary Zenker |

Research Analyst

Mary Zenker

Mary Zenker is a former research analyst in the Research Department at the Federal Reserve Bank of Cleveland.

11.08.11

Economic Trends

Emergency Unemployment Compensation and Long-term Unemployment

Murat Tasci and Mary Zenker

The recent recession was the longest on record since the Depression. As it wore on, more and more workers entered the ranks of long-term unemployed. To minimize the impact of these unemployment conditions on household incomes, the federal government implemented an unemployment insurance benefit called the Extended Unemployment Compensation (EUC) program. The program allows unemployed workers to collect unemployment insurance benefits longer than they normally would be able to. In this article, we provide some context for interpreting the program’s effect on the unemployment rate.

The EUC program was implemented in tiers. In June 2008 (7 months after the recession started), Congress legislated the first tier: unemployed workers could receive an additional 13 weeks of benefits. Five months later, that period was extended an additional 7 weeks and henceforth referred to as Tier 1. Tier 2 was introduced at the same time and gave an additional 13 weeks of benefits to those in states with unemployment rates above 6 percent. A year after it was enacted, Tier 2 extended benefits by 1 week and made the extension unconditional on state unemployment rates.

As the economy continued to stagnate, more tiers were introduced. In November 2009, the Tier 3 extension went into effect, adding 13 weeks of benefits in states with unemployment rates above 6 percent, and Tier 4 gave an additional 6 weeks of benefits in states with unemployment rates above 8.5 percent. All of the tiers together amount to a potential maximum additional benefit duration of 53 weeks. Adding that to the what the states provide—the traditional 26 weeks of benefits and 20 additional weeks of extended benefits—amounts to potentially being able to receive unemployment insurance benefits for 99 weeks (just about 2 years).

Initially, EUC benefits were available to anyone who had exhausted his or her regular benefits before March 28, 2009. However, as the recession wore on this date was continually moved later and later and is currently January 3, 2012.

Unemployment insurance is intended in general to provide some additional income during extended periods of unemployment, but it also creates incentives that can lead to effects that would otherwise not occur. One possible incentive might be that unemployment insurance encourages people to stay in the labor force who would otherwise drop out, since receiving benefits is conditional on searching for work. Or unemployment insurance might incentivize people to reject employment offers by raising their reservation wage, the wage above which they will accept a job.

We can check the data to see if either of these effects is occurring as a result of EUC. Consider first whether EUC incentivizes unemployed workers to stay in the labor force when they would otherwise drop out. As their EUC benefits expire, unemployed workers can choose to leave the labor force or to stay in. If they leave, the number of long-term unemployed workers will decrease (all else equal), since, by definition, a worker receiving EUC is counted among the long-term unemployed. If they stay, they continue to seek work but receive no further unemployment benefits.

If EUC creates this incentive, we ought to observe evidence of workers exiting the labor force as their benefits expire. Over the past two years, however, though we have seen a noticeable decline in the number of those receiving EUC and extended state benefits, the number of long-term unemployed workers has been stuck around 6 million and shows little sign of downward momentum.

The earliest workers who took advantage of of the full 99 weeks of unemployment insurance would have used up all their benefits around June 2010. As can be seen in the chart below, the number of people receiving EUC began declining markedly in 2010.

The fact that the decline in EUC recipients has not been coupled with a decline in the long-term unemployed suggests those workers are staying in the labor market. This is not certain, however, as there are constant inflows to the long-term unemployed pool from the “medium”-term unemployed pool. Additionally, staying in the labor force is not unequivocally bad. Some analysis by Jesse Rothstein suggests that EUC, because it keeps workers in the labor force, may have increased the share of unemployed workers who were later reemployed.

Consider now whether EUC creates an incentive to reject employment offers. In the chart below, we show a rough approximation of a statistic called a replacement rate. The replacement rate measures how much of their prior income EUC recipients are able receive with EUC. We lack direct data on this, but we can measure how much the average EUC benefits in a state are relative to the average wage in that state. This statistic is our proxy for the replacement rate. With an average replacement rate across all states of about 36 percent, we can surmise that when workers are receiving unemployment benefits, they are generally dealing with a nontrivial decline in income. This creates some uncertainty about the strength of the claim that receiving EUC provides an incentive to turn down a wage offer.

However, these incentive effects could be weaker when there are not many job openings available in the economy. We can look at a metric called market tightness to relate the number of unemployed persons to the number of available jobs. Essentially, this measure gives the number of vacancies per unemployed worker. When market tightness is really low, there are too many unemployed workers chasing too few job openings. Looking at this metric, we see a low level of market tightness in the economy, suggesting there is a low probability of exiting the unemployment pool on average. Potentially, a low demand for labor will dampen the incentive effects of unemployment insurance benefits. Hence, a more plausible reason for the elevated level of the long-term unemployed is a lack of demand for labor, rather than an incentive effect of EUC motivating people to stay in their current unemployed state.

Given that EUC significantly lengthened the length of time benefits could be received and increased the number of eligible workers, the existence and significance of these incentive effects on the unemployment rate is a key issue. An EUC incentive effect may be there, but the data shown here, even though only suggestive, do not indicate a very strong effect. Our reading of the economic literature on this issue suggests that the effect of the EUC is relatively minimal, accounting for about 0.6 to 0.8 percentage points of the unemployment rate by the end of 2010 (see the Rothstein paper mentioned earlier). The Rothstein study focuses on both of the incentive effects mentioned above and provides evidence that the unemployment exit rate was not significantly affected by the availability of EUC. The low levels of job openings we observe in the data support this view, suggesting that the scarcity of available jobs might explain the bulk of the unemployment rate.