On-the-job search equilibrium with endogenous unemployment benefits

This paper develops an on-the-job search model with wage posting where unemployment benefits are proportional to past wages. We emphasize that this contributes to increasing the reservation wages of unemployed workers and introduces a feedback effect of the distribution of wages on the distribution of unemployment benefits. We show that the model predictions are consistent with some stylized French facts and quantify the impact of inefficient rejections of low-wage offers by the unemployed. We find that, by reducing the indexing of unemployment benefits to previous earnings and increasing lump-sum transfers, it is possible to increase both employment and welfare. (C) 2009 Elsevier B.V. All rights reserved.