Optimal Unemployment Insurance with Monitoring

Monitoring the job-search activities of unemployed workers is a common gov- ernment intervention. I model monitoring in the optimal unemployment insurance framework of Hopenhayn and Nicolini (1997), where job-search e¤ort is private in- formation for the unemployed worker. In the model, monitoring provides costly imperfect information upon which the government conditions the unemployment bene ts. In the optimal monitoring scheme, random monitoring, together with endogenous sanctions and rewards, create e¤ective job-search incentives for the un- employed worker. For CRRA utility, the monitoring frequency increases and the spreads decrease with promised utility, if and only if the coe¢ cient of risk aver- sion 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.