Will Extension of Unemployment Benefits Help or Hurt the Economy?

On July 22, President Obama signed an extension of unemployment benefits. Benefits averaging $300 per week, normally available for a maximum of 26 weeks, can now be paid for up to 99 weeks. Such an extension had been in force previously during the recession, but it had lapsed. Benefits will be paid retroactively for the 7 weeks during which the extension was not in force.

Politically, the extension was highly controversial, passing the Senate by a single vote. The close vote reflects the likelihood that extended unemployment benefits will have both good and bad effects on the economy.

The case favoring extension begins from the fact that long-term unemployment is now at a post-World War II high. Some 45% of all unemployed workers have been out of work for 26 weeks or more. The long-term unemployment rate always rises during a recession, but the previous peak number of long-term unemployed, in the early 1980s, was less than half of the current number. If we add the fact that unemployment disproportionately affects the lowest-paid and least educated workers, it is not surprising that many people see the extension as good social policy.

In terms of its effects on the labor market, the extension of unemployment benefits can be expected to have both positive and negative effects. Unemployment benefits lower the opportunity cost of job search. Other things being equal, that will tend to increase the average duration and rate of unemployment. (It should be pointed out that that is not entirely bad--lowering the cost of job search can potentially improve matching of workers to jobs and thereby improve labor market efficiency.) At the same time, the extension of benefits will stimulate aggregate demand. To the extent doing so speeds the recovery of real output, unemployment will fall.

Critics of the extension pointed out that any short-term benefits must be offset against the fact that more current spending will complicate the job of bringing the federal deficit and debt under control over the medium term. The rapid rise in the debt during the recession has limited the government's room for undertaking additional short-term stimulus. Several spending and tax-relief provisions were stripped out of the recent bill before passage.

Follow this link to download a free set of classroom-ready slides that include both current unemployment data and a simple presentation of a job-search model of unemployment.