Unemployment Benefit Extension at the Zero Lower Bound

Abstract

In this paper, we investigate the impact of the recent US unemployment benefit extension on labor market dynamics when the nominal interest rate is held at the zero lower bound (ZLB). Using a New Keynesian model, our quantitative experiments suggest that, in contrast to the existing literature that ignores the liquidity trapsituation, the unemployment benefit extension has reduced unemployment by 0.7 percentage points on average. The inflationary pressure caused by the benefit extension reduces the real interest rate and offsets the job search effects and the drop in firms' vacancy postings resulting from the increase in wages. Outsidethe ZLB, it has adverse effects on unemployment. Furthermore, the ZLB explains 0.9 percentage points of the rise in unemployment. (Copyright: Elsevier)