International Finance Discussion Papers (IFDP)
Sectoral Shocks, Reallocation, and Labor Market Policies
Joaquin Garcia-Cabo, Anna Lipinska, and Gaston Navarro
Unemployment insurance and wage subsidies are key tools to support labor markets in recessions. We develop a multi-sector search and matching model with on-the-job human capital accumulation to study labor market policy responses to sector-specific shocks. Our calibration accounts for structural differences in labor markets between the United States and the euro area, including a lower job-finding rate in the latter. We use the model to evaluate unemployment insurance and wage subsidy policies in recessions of different duration. We find that, after a temporary sector-specific shock, unemployment insurance improves both productivity and reallocation toward productive sectors at the cost of initially higher unemployment and, thus, human capital destruction. In the United States, unemployment insurance is preferred to wage subsidies when it does not distort job creation for too long. By contrast, wage subsidies reduce unemployment and preserve human capital, at the cost of limiting reallocation. In the euro area, where the job-finding rate is lower, subsidies are preferred.
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