A Note on Firing Costs and Severance Benefits in Equilibrium Unemployment

The effects of severance benefits on the behavior of unemployment and vacancies are explored in a framework developed by Pissarides (1985) to analyze the effects of employment subsidies and unemployment benefits under various financing assumptions. In this setup, the key determinant of the effect of firing costs incurred by the firm and severance benefits received by the worker is the difference between the two. When this difference is positive, an exogenous increase in the separation rate leads to an increase in the equilibrium unemployment rate and the unemploymentvacancy ratio. An increase in the burden to the firm beyond the benefit received by the worker has similar effects. The sensitivity of the unemployment/vacancy ratio and, under certain conditions, the unemployment rate, to the separation rate is positively related to the excess of firing costs over severance benefits.