The Effect of Unemployment Benefits and Nonemployment Durations on Wages∗

We estimate that Unemployment Insurance (UI) extensions reduce reemployment wages using sharp age discontinuities in UI eligibility in Germany. We show this effect combines two key policy parameters: the effect of UI on reservation wages and the effect of nonemployment durations on wage offers. Our framework implies if UI extensions do not affect wages conditional on duration, then reservation wages do not bind. We derive resulting instrumental variable estimates for the effect of nonemployment durations on wage offers and bounds for reservation wage effects. The effect of UI on wages we find arises mainly from substantial negative nonemployment duration effects. ∗We would like to thank David Card, Kyle Herkenhoff, Hilary Hoynes, Larry Katz, Pat Kline, Kevin Lang, Rafael Lalive, Claudia Olivetti, Daniele Paserman, Luigi Pistaferri, Robert Shimer, Fabien Postel-Vinay, Albert Yung-Hsu Liu, as well as seminar participants at Boston University, the University of Chicago, Stanford, the ETH Zurich, Princeton University, Northwestern University, Northeastern University, Ohio State University, University of California Los Angeles, University of California Riverside, the Atlanta FRB, the Minnesota FRB, the NY FRB, the American Economic Association Meetings, the Society of Labor Economics, and the NBER Labor Studies meeting and four anonymous referees for helpful comments on this project. Johannes Schmieder gratefully acknowledges funding from the 2011 Scholars Program of the Department of Labor. All errors are our own. † [email protected] ‡ [email protected] § [email protected]