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Abstract
Unemployment insurance (UI) programs provide temporary and partial compensation to involuntary unemployed workers and help stabilize the economy during business recessions. Many economists believe that UI programs are important automatic stabilizers. Several previous studies show that unemployment benefits quickly increase during business downswings.
This study applies a vector autoregressive (VAR) model with cointegration constraints to analyze the effectiveness of state compensation programs as an automatic stabilizer at the state level. A review of unit roots, cointegration, and VAR models are discussed.
Initially, eight states were selected. These states are California, Idaho, Louisiana, Maine, Michigan, Missouri, New York, and Texas. Four state-level variables and two national variables were considered in each state. Unit root tests were conducted and it was found that only four states, California, Idaho, Michigan, and Missouri, were suitable for conducting cointegration tests. These tests showed that there were some cointegrating relationships among variables. The VAR model was then applied to analyze the effectiveness of the UI program as an automatic stabilizer in the respective state economies.
Results from variance decompositions and impulse response analyses of the variables in each state are discussed in this study. The results show that state UI programs are generally ineffective as an automatic stabilizer in the states analyzed in this study. Even if there is a countercyclical movement of unemployment benefits and tax collections, UI programs do not have a significant impact upon state economic activity. An increase in UI benefit payments and tax contributions cause an instantaneous change in nonfarm personal income. However, the change is too small to be an effective stabilizing tool in the state's economy.
