A Dynamic Model if the Cyclical Behavior of Employment with Unemployment Insurance

Abstract

This paper develops a model of a firm's optimizing behavior under the existence of the U.S. Unemployment Insurance System. The relationships among changes in employment and output fluctuations in response to shocks in the demand for output are highlighted. The production function of the model incorporates the training costs of new hires. Two effects of the Unemployment Insurance System on the dynamics of employment are considered: The firm keeps a labor force pool of workers for possible recall, since the unemployment benefits increase the reservation wage and therefore decrease the probability of workers getting an acceptable job offer. The benefits paid to the workers who are laid off are charged to the firm's account and this may increase the tax rate on the Unemployment Insurance Tax paid by the firm. The effects of different tax structures on the transition equations for the state variables and on the dynamic paths of the firm's control variables are investigated with simulations of the model. The steady state solution of a simplified version of the model with oscillatory demand is analyzed. Empirical and theoretical implications are also discussed.