While much empirical research exists on labor market consequences of unemployment benefits, there is remarkably little evidence on the forces determining benefits. We present a simple model where workers desire insurance against unemployment risk and benefits increase the unemployment rate. We then conduct one of the first empirical analyses of the determinants of the parameters of the benefit system. Using data for developed countries for 1971–89, controlling for year and country fixed effects and the government's political color, we find evidence that the level of benefits falls when the unemployment rate is high. This is consistent with Wright's tax effect.

We use a new approach to study questions in political economy that relies on data on the subjective well-being of a large sample of people living in the OECD over the period 1975–1992. Controlling for the personal characteristics of the respondents, year and country fixed effects and country-specific time trends, we find that the data describe social happiness functions for left-wing and right-wing individuals where inflation and unemployment enter negatively. We use these functions to test the root assumption of partisan business cycle models. The evidence is consistent with the hypothesis that left-wing individuals care more about unemployment relative to inflation than right-wingers. Interestingly, we find that individuals declare themselves to be happier when the party they support is in power, even after controlling for macroeconomic variables. The effect of politics is large. Finally, we find that these partisan differences cannot be traced back to income differences. That is, it is misleading to assume—as it is done in the previous literature—that the poor (rich) behave similarly to the left (right). For example, inflation and unemployment do not have differential effects across rich and poor and the happiness levels of these two groups are unaffected by the identity of the party in power. Our findings are hard to explain using median voter models but are to be expected in a partisan world.

In the many years since their introduction, positive theories of inflation have rarely been tested. This paper documents a negative relationship between inflation and the welfare state (proxied by the parameters of the unemployment benefit program) that is to be expected in such theories. Because unemployment benefits make the monetary authority less concerned about the plight of the unemployed, building a welfare state has a similar effect to appointing a conservative central banker. The relationship holds in a panel of 20 OECD countries over the period 1961–1992, a region where Romer finds no evidence of commitment problems. It holds controlling for country and time fixed effects, country specific time trends, other covariates, and using a decadal panel. Interpreted as causal, the estimated effect is economically large: a 1-standard deviation decrease in benefit duration is predicted to add 1.4 percentage points onto inflation, or 31% of the standard deviation in inflation.

We show that macroeconomic movements have strong effects on the happiness of nations. First, we find that there are clear microeconomic patterns in the psychological well-being levels of a quarter of a million randomly sampled Europeans and Americans from the 1970s to the 1990s. Happiness equations are monotonically increasing in income, and have similar structure in different countries. Second, movements in reported well-being are correlated with changes in macroeconomic variables such as gross domestic product. This holds true after controlling for the personal characteristics of respondents, country fixed effects, year dummies, and country-specific time trends. Third, the paper establishes that recessions create psychic losses that extend beyond the fall in GDP and rise in the number of people unemployed. These losses are large. Fourth, the welfare state appears to be a compensating force: higher unemployment benefits are associated with higher national well-being.

Preferences over Inflation and Unemployment: Evidence from Surveys of Happiness by Rafael Di Tella, Robert J. MacCulloch and Andrew J. Oswald. Published in volume 91, issue 1, pages 335-341 of American Economic Review, March 2001