Unemployment, Imperfect Risk Sharing, and the Monetary Business Cycle

Abstract

This paper examines the impact of unemployment insurance on the propagation of monetary disturbances in a staggered price model of the business cycle. To motivate a role for risk sharing behavior, I construct a quantitative equilibrium model that gives prominence to an efficiency-wage theory of unemployment based on imperfectly observable labor effort. Dynamic simulations reveal that under a full insurance arrangement, staggered price-setting is incapable of generating persistent real effects of a monetary shock. Introducing partial insurance, however, bolsters the amount of endogenous wage rigidity present in the model, enriching the propagation mechanism. Positive real persistence appears in versions of the model that exclude capital accumulation as well as in versions that do not.

Unemployment, Partial Insurance, and the Multiplier Effects of Government Spending

“…That is because partial insurance, through its influence on the wage‐setting process, actually bolsters the amount of endogenous price rigidity in the model. So even though the frequency of price changes is the same, the magnitude of those changes are much smaller (e.g., Givens, 2008, 2011). And like increases in exogenous rigidity, this works to moderate the impact of spending shocks on inflation (see also Figure 8).…”

Unemployment insurance in a sticky-price model with worker moral hazard

“…The maximumlikelihood strategy employed here enables the researcher to formally test the null hypothesis of complete risk sharing against the alternative of partial insurance. Givens (2008) develops a monetary business cycle model that combines sticky prices with imperfectly observable labor effort. Similar to the present study, his model also features an insurance mechanism that allows for varying degrees of risk sharing.…”