Labor Market Institutions and the Cost of Recessions

IMF Working Papers, April 3, 2017

Source details

Canonical URL

Labor Market Institutions and the Cost of Recessions

Other formats

• Markdown version
• Structured JSON version
• Bundle manifest

Bibliographic details

• Authors: Tom Krebs, Martin Scheffel
• Published: April 3, 2017
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781475592245.001

Summary and research question

• Studies the effect of two labor market institutions, unemployment insurance (UI) and job search assistance (JSA), on the output cost and welfare cost of recessions.
• Develops a tractable incomplete-market model with:
  • search unemployment,
  • skill depreciation during unemployment,
  • idiosyncratic as well as aggregate labor market risk.
• Central theoretical result: an increase in JSA and a reduction in UI reduce the output cost of recessions by making the labor market more fluid along the job finding margin and thus making the economy more resilient to macroeconomic shocks.
• Ambiguity result: the effect of JSA and UI on the welfare cost of recessions is in general ambiguous.

Theoretical framework and mechanisms

• Model features:
  • incomplete markets,
  • search unemployment,
  • skill depreciation during unemployment,
  • both idiosyncratic and aggregate labor market risk.
• Mechanism for output cost reduction:
  • Increased JSA and reduced UI raise labor market fluidity via the job finding margin.
  • Greater fluidity makes the economy more resilient to macroeconomic shocks, lowering the output cost of recessions.
• Welfare considerations:
  • Despite clearer effects on output cost, the model implies ambiguous effects of JSA and UI on the welfare cost of recessions.

Quantitative application: German labor market reforms (Hartz reforms)

• Case study: German labor market reforms of 2003-2005 (Hartz reforms).
  • Hartz III reform: improved JSA.
  • Hartz IV reform: reduced UI.
• Baseline calibration results:
  • The two labor market reforms led to a substantial reduction in the output cost of recessions in Germany.
  • The two labor market reforms led to a moderate reduction in the welfare cost of recessions in Germany.

Policy implications and interpretation

• Policy mix evaluated:
  • Enhancing JSA (job search assistance) and reducing UI (unemployment insurance) can be complementary for reducing output losses in recessions through improved job finding and labor market fluidity.
• Caution on welfare outcomes:
  • Policymakers should note the ambiguity in welfare effects; reductions in output cost do not automatically translate into unambiguous welfare gains.
• Relevance for reforms:
  • The Hartz III and Hartz IV reforms in Germany provide a quantitative example where these policy adjustments coincided with reductions in both output and welfare costs of recessions (substantial output cost reduction; moderate welfare cost reduction).

Content in this bundle

• Labor Market Institutions and the Cost of Recessions, WP/17/87, April 2017
  • Labor Market Institutions and the Cost of Recessions, WP/17/87, April 2017 (Markdown version)
  • Labor Market Institutions and the Cost of Recessions, WP/17/87, April 2017 (PDF)