This paper provides estimates of the causal effect of unemployment duration on wages. The paper shows that if the path of reemployment wages throughout the unemployment spell does not shift in response to unemployment insurance (UI) extensions this implies reservation wages do not bind. Under this condition, UI extensions can be used as an instrumental variable (IV) to obtain the average causal effect of unemployment duration among all individuals whose
unemployment duration responds to the policy change. UI extensions occurring with exact age in Germany had small but precisely estimated effects on wages, without affecting the path of reemployment wages. The resulting IV estimates yield substantial negative effects of unemployment duration on wages of 0.8% per month. This estimate implies that declines in wage offers over the unemployment spell can explain about a third of average wage declines at unemployment, and that wage reductions can substantially raise the costs of long-term unemployment. |
