Unemployment benefit extensions at the zero lower bound

• We develop a New Keynesian DSGE model with frictional unemployment.
• We study the US unemployment insurance benefit extension (2008) in a liquidity trap.
• The unemployment benefits extension slightly reduces unemployment at the ZLB.
• Outside the ZLB it strongly increases unemployment.
• The ZLB account for 0.9 percentage point of the observed rise in unemployment.

In this paper, we investigate the impact of the recent US unemployment benefit extension on labor market dynamics 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, the unemployment benefit extension has reduced unemployment by 0.7 percentage points on average. The inflationary pressure caused by the benefit extension reduces the real interest rate and offsets the job search effects and the drop in firms' vacancy postings resulting from the increase in wages. Outside the ZLB, it has adverse effects on unemployment. Furthermore, the ZLB explains 0.9 percentage points of the rise in unemployment.