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Why Congress should not extend unemployment benefits

President Obama wants Congress to again extend unemployment benefits. That's a hard request to resist, politically. But the economic impact of extending jobless benefits is that wages will not fall quickly enough to create more jobs.

By David C. Rose / September 20, 2011



St. Louis

The president is calling for yet another extension of unemployment benefits. For members of Congress, such extensions have evolved into a new “third rail” of politics – so they don’t dare oppose them.

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But in reality, extending unemployment benefits again will interfere with an important mechanism by which the economy recovers on its own. Congress should say no.

John Maynard Keynes argued that recessions are prolonged by wages falling much more slowly than assumed in the models of classical economics. Virtually all economists agree with this point. Like most economists, then and now, Keynes believed that if wages could fall very rapidly, labor markets would clear quickly and therefore unemployment would be short-lived.

Rapidly falling wages produce jobs

For this reason, Keynesian and nonKeynesian economists alike view the speed at which wages fall in a recession to be important for rapid economic recovery. Falling wages increase the profitability of production, and this induces firms to produce more. This in turn leads to more hiring, faster economic growth, and a lower unemployment rate.

Virtually no economist disputes the claim that the faster that wages fall in a recession, the more quickly an economy will recover. Keynes certainly believed this. Keynes’ caveat was simply that this process takes too long, so we should use expansionary fiscal policy to hasten recovery by stimulating demand.

The most obvious way for wages to fall is for individuals to be paid less in the jobs they already have. Although some companies have introduced pay cuts, there are strong institutional impediments to doing so, and therefore most have not. But another way the economy can produce the same effect is if individuals, after losing a job, take new jobs at lower wages than the jobs they originally had.

What does this have to do with extending unemployment benefits?

Someone who is unemployed as a mechanical engineer might nevertheless be able to find a job as a production line worker. Extending unemployment benefits induces such an individual to keep looking for another engineering job. But if that individual took a job as a production line worker because unemployment benefits ran out, productivity in the new position would almost certainly increase – even though the wage associated with it did not rise.

Extending jobless benefits makes wages rigid

Because extending unemployment benefits makes many individuals less willing to take new jobs at lower pay, it adds to wage rigidity, which Keynes (correctly) argued prolongs recessions.

There is abundant empirical evidence that unemployment benefits induce workers to keep looking for a job like the one they lost (see previous work by Alan Krueger, the president’s new top economic advisor). So extending unemployment benefits yet again will interrupt a potentially important mechanism by which the economy self-corrects by effectively reducing real wages.

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