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Summary: The Role of Unemployment as an Automatic Stabilizer During a Recession

The Unemployment Insurance (UI) system helps the population most directly affected by recessions—those who have lost jobs through no fault of their own.  This focus makes it one of the most effective targeted tools for maintaining American families’ purchasing power and keeping the economy on track during an economic downturn.  Unemployment creates a snowball effect where people who have lost their job reduce their spending causing businesses to lose money and others to lose their jobs.  Unemployment insurance acts to reduce this effect by helping the unemployed to continue to purchase vital goods and services for their family. 

Now, new evidence from a study commissioned by the Labor Department during the Bush Administration reaffirms the value of UI as an automatic economic stabilizer during the latest recession.  This study was conducted by the research firm IMPAQ International in conjunction with the Urban Institute and using the macroeconomic model from Moody’s

The study found that UI benefits:

  • reduced the fall in GDP by 18.3%.  This resulted in nominal GDP being $175 billion higher in 2009 than it would have been without unemployment insurance benefits. In total, unemployment insurance kept GDP  $315 billion higher from the start of the recession through the second quarter of 2010;
  • kept an average of 1.6 million Americans on the job in each quarter: at the low point of the recession, 1.8 million job losses were averted by UI benefits, lowering the unemployment rate by approximately 1.2 percentage points;
  • made an even more positive impact than in previous recessions, thanks to the aggressive, bipartisan effort to expand unemployment insurance benefits and increase eligibility during both the Bush and Obama Administrations.  “There is reason to believe,” said the study, “that for this particular recession, the UI program provided stronger stabilization of real output than in many past recessions because extended benefits responded strongly.”
  • have a multiplier effect of 2.0: for every dollar spent on unemployment insurance, this report finds an increase in economic activity of two dollars. 

Notably, the IMPAQ/Urban Institute study did not include the July 2010 extension of federal benefit expansions. Had it done so, the study might have found even greater impacts of UI benefits on the economy.

During normal economic times, the UI system pays benefits for up to 26 weeks to workers who lose their jobs through no fault of their own.  The fact that unemployment insurance program benefits automatically kick in helps laid-off workers pay their bills and keep food on the table while they seek new employment. During recessionary periods, when the unemployment rate increases significantly and few job opportunities exist, the UI system acts as an “automatic stabilizer” for the economy, helping break the downward spiral between widespread layoffs, cutbacks in families’ budgets, and declining economic activity.  UI benefits allow the unemployed to maintain more of their previous consumption than they would otherwise be able to.  When the unemployed cut back on spending, the business owners that serve them lose.  By cushioning the fall in these families’ incomes, unemployment insurance not only helps the families that receive it, but also prevents further production cuts and layoffs.  Unemployment insurance directly helps the jobless, and it averts joblessness.  This study shows that in this recession unemployment insurance to the unemployed kept unemployment from rising to over 11%.

Historically, Congress has reacted to recessions by expanding the UI program, extending the duration of benefits—making UI a more powerful stabilizer.  In this worst recession since the Great Depression Congress and both the Bush and Obama Administrations took multiple steps to enhance the UI system:

  • First, in June 2008, Congress passed the Emergency Unemployment Compensation (EUC) Act, providing an additional 13 weeks of benefits to the regular UI program. While unemployment insurance is run at the state level and funded by both state and federal taxes, EUC is 100% federally-financed
  • In November 2008, EUC was expanded to 20 weeks, with some states eligible for 33 weeks if their statewide unemployment rate as published by the Bureau of Labor Statistics exceeded 8 percent. 
  • In February 2009, with the economy losing more than 700,000 jobs a month, President Obama signed the American Recovery and Reinvestment Act of 2009 (ARRA).  Among the many provisions of the Recovery Act were $288 billion in tax cuts and benefits for millions of working families and businesses, which included further enhancements to the UI system, an extension of EUC to December 2009, an increase of $25 in weekly benefit payments, and an exemption of the first $2400 from federal income taxes.  Since the passage of the Recovery Act, Congress has postponed EUC’s expiration five times, but the program is currently set to expire on November 30, 2010.
  • ARRA also bolstered state Extended Benefits (EB) programs by temporarily providing them with full federal funding. EB, which provides up to 20 weeks of additional unemployment insurance benefits in states with high unemployment rates, is typically funded by both the state and federal governments. The 100% federal financing of EB, which also expires at the end of November, has prompted many states to change their laws, providing for extended benefits in dozens of states where they would not otherwise have been available during much of the recession.

As a result of these extensions and as demonstrated by the IMPAQ study, the UI system supported workers and the economy more than ever in the recent recession.  As the Census Bureau recently estimated, UI benefits helped to keep 3.3 million people, including 1 million children, out of poverty in 2009.  With nearly 15 million workers currently unemployed, more than 40 percent of whom have been out of work for more than six months, both the regular and extended UI programs are as necessary as ever to support families on the margins of the labor market and support the ongoing recovery.

The IMPAQ/Urban Institute study was initially commissioned in 2004 to examine the macroeconomic impacts of unemployment insurance. Using actual data from the recession and the proprietary economic model from Moody’s, the researchers made retrospective simulations to examine how GDP, employment, and other economic variables would have performed without the increase in regular UI benefits, federally-funded Emergency Unemployment Compensation and extended benefits, and payroll taxes that pay for UI. The study was performed prior to the July 2010 extension of UI benefit expansions, and so the impact of these benefits was not included in the analysis.