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Optimal Unemployment Insurance with Monitoring

Setty, Ofer (2011): Optimal Unemployment Insurance with Monitoring.

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Monitoring the job-search activities of unemployed workers is a common government intervention. I model monitoring in the optimal unemployment insurance framework of Hopenhayn and Nicolini (1997), where job-search effort is private information for the unemployed worker. In the model, monitoring provides costly imperfect information upon which the government conditions the unemployment benefits. In the optimal monitoring scheme, random monitoring, together with endogenous sanctions and rewards, create effective job-search incentives for the unemployed worker. For CRRA utility, the monitoring frequency increases and the spreads decrease with promised utility, if and only if the coefficient of risk aversion is greater than (1/2). Compared to optimal unemployment insurance, monitoring saves, at the balanced budget point, about eighty percent of the cost associated with moral hazard. The gain is achieved by a decrease of more than half in the standard deviation of consumption.

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