Search frictions, real wage rigidities and theoptimal design of unemployment insurance: a study in a DSGE framework

In this paper, we feature the optimal unemployment benefits financing scheme when the economy is subject to labor market failures characterized by search frictions and wages rigidity. We show how policy instruments should interact with labor market imperfections. The US unemployment insurance financing is such that firms are taxes in proportion of their layoffs. The question of the optimal tax schedule naturally arises. Using the DSGE methodology, we investigate the optimal design of the unemployment benefits financing scheme. The welfare gains and the stabilizing effects of this policy are evaluated. If unemployment benefits and layoff taxes are chosen in an appropriate way, welfare and labor market performances can be improved. Search externalities and wage rigidities cause sizeable welfare losses and influence the optimal design of the financing scheme. Without wage rigidities the efficient layoff tax corresponds to the expected fiscal cost of an unemployed worker. Conversely, when wages are rigid, the cost firms should support is much higher.