The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
This paper 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. The paper develops a
tractable incomplete-market model with search unemployment, skill depreciation during
unemployment, and idiosyncratic as well as aggregate labor market risk. The theoretical analysis
shows that 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. In contarst, the effect of JSA and UI on the welfare cost of
recessions is in general ambiguous. The paper also provides a quantitative appliation to the German
labor market reforms of 2003-2005, the so-called Hartz reforms, which improved JSA (Hartz III
reform) and reduced UI (Hartz IV reform). According to the baseline calibration, the two labor
market reforms led to a substantial reduction in the output cost of recessions and a moderate
reduction in the welfare cost of recessions in Germany.