Optimal Unemployment Insurance and International Risk Sharing

Abstract

In this paper, we discuss how cross-country unemployment insurance can be used to improve international risk sharing. We use a two-country business cycle model ugmented by a search labour market and incomplete financial markets and let the unemployment insurance scheme operate across both countries. We find that cross-country insurance through the unemployment insurance system can in principle be achieved without distorting national labour markets, and that international risk-sharing introduces a countercyclical element to the unemployment insurance tradeoff. When we calibrate our model to the Euro area, the optimal supranational policy makes replacement rates countercyclical, while they would be procyclical in the absence of cross-country transfers. Recent Eurozone policy proposals, by contrast, seem to have only limited effects.