Optimal STW policy: Benefits up, eligibility tighter in downturns

The study develops a search and matching model to derive optimal STW policy.

It finds that while unemployment insurance (UI) provides income insurance, STW mitigates the fiscal externality caused by UI-induced job separations.

Crucially, the model shows STW's existence is contingent on the UI system.

In recessions, optimal STW benefits should increase, aligning with common practice.

However, contrary to actual policy, optimal eligibility criteria for STW participation must be tightened to limit excessive firm entry and contain distortions in working hours.

This counter-intuitive finding is driven by the need to balance increased social costs of separations during downturns with the distortionary effects of generous STW.

The paper quantifies that optimal STW policy can close 33 percent of inefficient aggregate consumption fluctuations and 57.5 percent of inefficient employment fluctuations.

The research addresses a conceptual gap in understanding the optimal interaction between STW and UI, particularly how STW should adjust over the business cycle.

The model incorporates risk-averse workers, flexible working hours, endogenous separations, and generalized Nash bargaining.

It highlights that the UI system, by increasing workers' outside options, can lead to inefficiently high separation rates and unemployment.

STW effectively reduces these inefficient separations by lowering firms' salary costs during downturns, thereby offsetting the fiscal burden created by the UI system.

However, STW benefits must also internalize their own distortionary effects on working hours, preventing full internalization of the fiscal externality.