The scenario:

The US government greatly expands aid to the unemployed. Unemployed workers now receive benefits equal to 75% of their previous wages, and these benefits will continue indefinitely as long as the unemployed workers are unable to find work. The new benefits would not be financed by new taxes; the government will simply borrow the money. (Assuming a closed economy, this means borrowing against our future, or deficit spending.) Show what you think the would result from this policy for output, unemployment rate, interest rates, and the price level in the short and long run.

A complicated economics problem requires a complicated, analytical response. I lack the expertise to offer such a response with authority, but I am arrogant enough to take on the task and assume I know what I am talking about.

Unemployed persons are defined as having no employment and being available for work during the week before the Current Population Survey and either had made efforts to find employment within the previous four weeks or were waiting to be recalled to a job from which they had been laid off. It is worth noting that unemployed persons do not include non-participating members of the working-age population -- that is, working-age persons who are unwilling to work.

I would imagine that, should unemployment benefits be inflated to such levels as 75% of previous wages and not expire until work is found, unemployment would gradually but sure increase. As a matter of fact, the labor force participation rate would decrease, and those actively seeking work would decrease and technically not qualify for unemployment benefits. However, with benefits at such levels, seeking loopholes to remaining a part of the labor force without actually sincerely seeking work would become an art form -- at least, more than it already is. With the ability to earn 75% of previous wages without actually working for it while enjoying considerably more leisure time, the incentive to work would be greatly reduced and the "unemployed" label would not be incentive enough to get many of the lazier Americans back to work.

To this end, as I have explained, unemployment would rise, though by virtue of the true aim of the unemployed population, "real" unemployment would actually not increase, and the "real" labor force participation rate would decrease. But because of various legal loopholes, people who should not qualify would find ways to earn unemployment benefits.

Conceivably, the personal benefits of such unemployment could lead directly to an unemployment "boom"; the unemployment rate could conceivably double, triple, or worse. (Really: why work if you can make 75% of your check for doing next to nothing?) If the trend got out of hand too quickly, production (output) could suffer badly. Fewer workers would be required to work longer, hopefully more efficient hours, and would likely be paid higher wages for their work.

Still, if the percentage of the labor force that is employed is too greatly reduced, the workers left may not be enough to keep production up, and real GDP could fall. With expectations of reduced output, aggregate demand would fall; depending on how much aggregate demand falls, price levels could rise slightly, drop slightly, stay about the same. In any event, reduced production and reduced individual income would generate less consumption expenditure, and eventually the price level would have to drop to account for a slower velocity of circulation. Interest rates would be lowered in order to encourage purchases of, well, anything, but drastically reduced output would trump drastically reduced interest rates, and an economy on the verge of collapse would virtually freeze, all but sealing a doomed economy's fate.

Such a drastic change in unemployment benefits policy could be catastrophic for an economy this size. The long-term effects are virtually impossible to predict, because at the first sign of trouble, Congress and the Federal Reserve would work diligently to correct the problem. Presumably, the new unemployment benefits plan would be scrapped if economists were able to pinpoint it as being at fault, and the economy would right itself naturally via equilibrium-seeking means, observing the laws of supply and demand. After all, our economy is built on expectations and habits, and no major problem survives for very long as long as consumers, firms, and the government make changes only a little at a time.

Economic doomsday scenario? Sure. Impossible? Well, not quite. (I really, really wanted to comment on the depreciation of the value of the dollar and global economic failure and the second coming of Japanese superiority in the global economy, but this is closed economy...)