The Credibility Problem in Unemployment-Insurance Policy

This paper studies the interaction between trade unions, which set wages, and a policymaker, who decides on the level of unemployment benefits and taxes. If the policymaker cannot commit to future policies, taxes and benefits are excessively high in equilibrium. Moreover, employment and output are inefficiently low. Appointing a policymaker who is more conservative than the median voter may solve the credibility problem. Alternatively, increasing wage flexibility may make the credibility problem less severe. Finally, I argue that, when evaluated behind a veil of ignorance, the credibility problem may be a blessing rather than a curse.