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The Impact of Unemployment Insurance and Unsecured Credit on Business Cycles

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  • Michael Irwin

Abstract

I study how unsecured credit affects the extent to which unemployment insurance (UI) policies smooth cyclical fluctuations in aggregate consumption. To do so, I develop a real business cycle model with incomplete asset markets, frictional labor markets, and defaultable debt. Using empirically consistent unemployment dynamics over the business cycle, the model generates the cyclical properties of unsecured revolving credit balances and consumer bankruptcies in the data. The model is used to quantify the aggregate implications of a policy that extends the duration of UI during recessions. The main quantitative result of this paper is that unsecured credit amplifies the extent to which UI policies smooth aggregate consumption fluctuations over the business cycle. Extensions in the duration of UI mitigate the rise in consumer bankruptcies during recessions. They also mitigate the rise in the risk premium on unsecured borrowing, which allows households to better smooth consumption.

Suggested Citation

  • Michael Irwin, 2023. "The Impact of Unemployment Insurance and Unsecured Credit on Business Cycles," Staff Working Papers 23-22, Bank of Canada.
    • Handle: RePEc:bca:bocawp:23-22
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    References listed on IDEAS

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    Cited by:

    1. Tuzcuoglu, Kerem, 2024. "Nonlinear transmission of international financial stress," Economic Modelling, Elsevier, vol. 139(C).

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    More about this item

    Keywords

    Business fluctuations and cycles; Credit and credit aggregates; Economic models; Fiscal policy; Labour markets;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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