Running Out of Time: Limited Unemployment Benefits and Wage Dispersion

We study unemployment insurance (UI) in a general equilibrium environment in which unemployed workers only receive benefits for a finite length of time. Although all workers have identical productivity and leisure value, the random arrival of job offers creates ex-post differences with respect to their time remaining until benefit expiration. Firms, which are also homogenous, can exploit these differences, leading to an endogenous wage distribution. We analyze the equilibrium effect of both the length and size of unemployment benefits on wages, duration of unemployment, unemployment rate, and welfare. When calibrated to match key US labor market statistics, our model predicts that a one month extension of benefits is welfare-improving, increasing the average wages by 0.01 percent and unemployment rate by 1.4 percent. On the other hand, a 10 percent increase in the size of benefits is welfare-reducing, causing a 0.03 percent decrease in wages and an increase in unemployment rate.