Unemployment and Welfare Participation in a Structural VAR: Rethinking the 1990s in the United States (Revised)

The Council of Economic Advisers (1997) started a large research effort about the relationship between the US unemployment rate and the welfare participation rate, with special regard to the 1990s. In this paper, this relationship is examined in a structural VAR over the period of 1960-2000. It is found that the unemployment rate does not Granger-cause the welfare participation rate, while the converse is true. Moreover, a negative shock to the welfare participation rate predicts a reduction in the unemployment rate. These results are robust to State and year heterogeneity over the period of 1990-1998. A first implication is that - contrarily to the majority view - the decline of the welfare participation rate in the last decade should be mainly attributed to restrictive welfare reforms, not to the fall in the unemployment rate. Further, the political choice to reduce the welfare participation rate may have inflated the reduction in the unemployment rate.