Cyclical Labor Market Policy Adjustments Under Wage Bargaining

Abstract

This paper analyzes the optimal cyclical behavior of labor market policies in an economy with asset and labor market frictions. The policies of interest include unemployment insurance (UI) and employment protection (EP). In addition to their supply-side effects, labor market policies affect the aggregate demand via earning risk and redistribution channels. Under bilateral wage bargaining, I find that procyclical UI and countercyclical EP deliver superior welfare outcomes through stabilization via both supply and demand channels.

Keywords: New Keynesian, Uncertainty, Unemployment, Incomplete markets, Labor market policy

JEL Classification: E12, E21, E24, E29, E32, E61, E69, J68, J65