Considering Both Supply And Demand in the Extending Unemployment Insurance Debate

Two things jumped out when we did our unscientific survey of conservative economists (part one, two) a few weeks ago. One is that conservative economists blamed “policy uncertainty” for a large part of the current unemployment crisis. I think Christina Romer excellent editorial on this uncertainty issue responds well to that complaint.

The other issue is that conservative economists really hate the idea of extending unemployment insurance.  Over half of them ranked it was the most counterproductive thing that could be done, saying that it is subsidizing unemployment.  Sadly this opinion doesn’t take into account the latest research we know about unemployment benefits.  It also doesn’t engages important role of considering both supply and demand when we are in a major recession.

That extending unemployment insurance might increase the unemployment rate isn’t a controversial concept.   The only question is by how much.   Rob Valletta and Katherine Kuang from the San Francisco Federal Reserve put out a research note, Extended Unemployment and UI Benefits, that found the initial wave of extending unemployment benefits only increased unemployment 0.4%. Why so low? Because, as you can see from their chart, conditions suck for everyone out there in the labor market:

Quits and entrants do not get unemployment insurance, job losers do. Yet they both have a jump in duration of unemployment. If the increase in unemployment insurance was the major driving the unemployment rate you would see job losers with significantly higher duration.

So supply: civilian labor force level is around 154 million people, so that 0.4% turns into 616,000 more people who are unemployed because of unemployment insurance. But what about labor demand?

Let’s look to the latest CEA report, The Economic Impact of Recent Temporary Unemployment Insurance Extensions, (h/t Felix Salmon), which finds that extending unemployment benefits have created 793,000 new jobs.  This number is far more than the number of unemployed it has discouraged from taking a job, so the net effect has been to create jobs.

This doesn’t occur through magic or underpants gnome logic. From the paper: “Economic research has found that without UI, a typical family whose head of household becomes unemployed would spend 22 percent less on food – as compared to the 7 percent drop that is actually observed because of the UI system.” It’s as simple as supply and demand, and extending unemployment insurance allows people to drop less consumption when they become unemployed, creating demand that wipes out any supply-side effect on labor. (See here for a math model on how this works.)

Mind you it’s also good from a humane point of view. That people in industries not even remotely related to the credit bubble should suffer because of securitization of dumb loans is a cruel view of how an economy should work.

The debate now is whether or not to extend these unemployment benefits.  The CEA estimates are that extending unemployment benefits will keep around 593,000 jobs in the economy.

Now that’s closer to the labor supply effect. But let’s split the labor supply effect into two parts. One is the nasty work disincentive effect that we don’t want to subsidize – we are paying people not to work. The other is a liquidity effect that we do want to help with – someone who could be a more productive doctor has to cut his job search short to work at McDonalds in order to put food on the table. Recent cutting edge research by Raj Chetty has found that 60% of the increase in search time is in the second category. That’s likely to be even much higher in a balance-sheet recession, when debts are high and job opportunities few.

EPI has a letter of 35 leading economists, including Rob Johnson and Joe Stiglitz of the Roosevelt Institute, encouraging Congress to extend unemployment insurance. It’s both humane, just and good economics.