Do Unemployment Benefits Expirations Help Explain the Surge in Job Openings?

by Fatih Karahan, Samuel Kapon, and Kaivan K. Sattar – Liberty Street Economics, Federal Reserve Bank of New York

Job openings are arguably one of the most important indicators of recovery in the labor market, as they reflect employers’ willingness to hire. The number of job openings has recovered steadily since the recession, yet through the end of 2013, the openings rate was still substantially below its pre-recession peak (see chart below). Starting in January 2014, however, the number of job openings increased dramatically, up by 20 percent through June 2014, and job openings relative to employment jumped back to the peak of the previous expansion. In this post, we argue that the expiration of the Emergency Unemployment Compensation (EUC) program may have contributed to this rapid rise in 2014.

First enacted in June 2008, the EUC was an important part of the policy response to the Great Recession involving expansion of unemployment insurance benefits (UI). Preexisting legislation provided for up to twenty-six weeks of UI and, in states with a high unemployment rate, the Extended Benefits (EB) program provided twenty additional weeks. EUC started by allowing for an extra thirteen weeks of benefits to all states and was gradually expanded to four tiers, providing up to fifty-three additional weeks of federally financed benefits. This extension increased the maximum duration to an unprecedented ninety-nine weeks. Despite the transitory nature of the program, the EUC was reinstated several times by U.S. Congress, but finally lapsed at the end of 2013. At that time, around 1.3 million unemployed workers lost unemployment benefits, an important source of income (around $300 per week on average).

How can the end of such an important fiscal stimulus, which at face value could be a drag on consumption, help the labor market and boost job openings? After all, one rationale for this program was to provide stimulus to a fragile economy. The mechanism that we offer as an explanation is based on firms’ response to UI and is not new. In fact, the Diamond-Mortensen-Pissarides model (Pissarides 2000, Mortensen and Pissarides 1994, and Diamond 1982), for which the Nobel Prize in Economics was awarded in 2010, predicts that increases in UI generosity put upward pressure on wages since it becomes more expensive to lure people into work. As a consequence, firms anticipate lower profits and cut back job creation, which lowers the job finding rate and increases the unemployment rate.

Most of the previous work on UI has focused on its effect on unemployed workers’ search behavior. Unemployed workers might respond to UI extensions by searching less intensively or by being picky about job opportunities. Several papers have estimated this effect to be small (see, for example, Rothstein [2011], Farber and Valletta [2013], andValletta [2014]). However, little was known about the effect on job creation, prior to recent work described below.

A new staff report by Marcus Hagedorn, Fatih Karahan, Iourii Manovskii, and Kurt Mitman (HKMM) provides empirical evidence that this channel, relating benefits expiration to job creation, might be big. Thanks to the design of the UI system, potential UI durations have evolved quite differently across states. The time-lapse video we created below shows the extent of variation across both time and space. HKMM exploit the variation by comparing the evolution of key labor market variables (such as unemployment, vacancies, and employment) in counties that border each other but belong to different states. Because locations separated by a border are expected to have similar labor markets but differ in policies, this research can provide an estimate of the effects of UI benefit extensions.

Benefits Duration, 2008-13

HKMM’s findings suggest that UI extensions do put upward pressure on wages, reduce job openings, and raise unemployment. How large are the magnitudes? In what follows, we offer estimates of how much the expiration of EUC affected job creation. More specifically, we take the data through January 2014 as given, and predict the evolution of the vacancy rate, assuming that the only change in the economy was the expiration of EUC.

Does the policy change explain the recent spike in job openings? HKMM’s results for the vacancy rate (depicted in the chart below) imply that the EUC expiration raised the job openings rate by 0.6 percentage point to 3.4 percent, remarkably close to the realized rate in the Job Openings and Labor Turnover Survey (JOLTS) report of 3.3 percent for June 2014. Charting the impact of the end of EUC on the vacancy rate over time requires making an assumption about how long the vacancy rate takes to converge to the non-EUC level following the expiration. Usually, vacancies are quick to adjust to changes in the labor market. However, there was uncertainty regarding the expiration of the EUC due to ongoing debates in Congress for reinstatement. Given that prior to its expiration in January 2014, the EUC had lapsed several times but was subsequently reinstated retroactively, we postulate a period of six month for firms to be convinced that the program isn’t coming back. The next chart shows a linear interpolation over six months between the job openings rate in January 2014 and its non-EUC level vis-à-vis the data. Note that in our analysis the expiration of the EUC alone explains quite well the sharp rise in job openings.

The predictions from the HKMM model for employment are shown in the chart below (see the red line). To make this forecast, we first compute the effect on the job finding rate of the EUC expiration. Then, assuming that it will take six months for the job finding rate to converge to the new level, we simulate labor market variables forward by six months, starting in January 2014 and assuming a constant separation rate fixed at January 2014. The model has the employment-to-population ratio rising in 2014, although at a faster pace than actually occurred. This discrepancy is possibly due to the decline in economic activity in the first quarter that is not accounted for in the simulation.

There are many factors affecting employment, but our analysis suggests that the expiration of the EUC increased the willingness of firms to hire, leading to the large increase in job openings in the first half of 2014.

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Source: http://libertystreeteconomics.newyorkfed.org/2014/09/do-unemployment-benefits-expirations-help-explain-the-surge-in-job-openings.html#.VCqTHvldUSg

About the Authors

Fatih Karahan is an economist in the Federal Reserve Bank of New York’s Research and Statistics Group.

Samuel Kapon is a senior research analyst in the Bank’s Research and Statistics Group.

Kaivan K. Sattar is a senior analyst in the Bank’s Risk Analytics Group.