Optimal Short-Time Work Policy in Recessions

Short-time work (STW) is a subsidy program linked to a reduction in working hours that has been widely used across Europe and partly used in some US states to combat job losses in the Great Recession and the COVID-19 pandemic. Although typically used alongside an unemployment insurance (UI) system, the interaction between STW and UI remains conceptually unclear. To close this gap in the literature, I develop a search and matching model of the labor market with risk-averse workers, flexible hours choice, endogenous separations, and generalized Nash bargaining. Deriving closed-form expressions for the optimal policy mix, I demonstrate that while the UI system provides income insurance to workers, the STW system mitigates the fiscal externality of UI-induced separations. Notably, STW only exists due to the UI system. Consistent with often observed policy practice, I allow the STW system to adjust over the business cycle while keeping the UI system constant. In line with the actual policy, my findings indicate that optimal STW benefits have to increase in recessions, while in contrast to the actual policy, optimal eligibility criteria have to be tightened. Using UI with an optimal STW system is fiscally less expensive than the UI system on its own.