ANNALS OF ECONOMICS AND FINANCE 12-2, 347–369 (2011) Optimal Unemployment Insurance with Endogenous Search Effort

In the framework of a search and matching model, when search effort en-ters the labor market matching function, search effort by one worker generates a negative externality on other workers searching for jobs. The solution to the social planner’s problem may not be decentralized in a competitive mar-ket. Calibration shows that the current US unemployment insurance (UI) system generates an 8.07 % welfare loss relative to the socially optimal allo-cation. An alternative scheme with higher replacement rate and lower wage, which achieves the highest welfare level among all competitive equilibria with unemployment insurance, leads to a welfare loss of only 1.18%