In this paper we investigate the impact of the recent US unemployment benefits extension on the labor market dynamic when the nominal interest rate is held at the zero lower bound (ZLB). Using a New Keynesian model, our quantitative experiments suggest that, in contrast to the existing literature that ignores the liquidity trap situation, unemployment benefits expansions cause a wage and inflationary pressure which curb the increase in real interest rate and slightly reduce unemployment at the ZLB. Outside the ZLB, it has adverse effects, meaning that unemployment insurance benefits should be adjusted according to the macroeconomic conditions if the scope is to reduce unemployment. Furthermore, the ZLB amplifies the labor market downturn. An unconstrained monetary policy rule, i.e. negative interest rate, could have reduced the unemployment rate by around 1 percentage point in the trough of the recession.
Zero lower bound New Keynesian models Matching frictions Monetary policy Unemployment benefits extensions