Many countries rely on monitoring of unemployment insurance and welfare recipients
and impose benefit sanctions in case of noncompliance with job search requirements to
encourage job search and to prevent abuse of the social insurance system. This paper systematically
analyzes the characteristics of optimal monitoring and sanctioning systems
for the unemployed as a function of worker characteristics, unemployment duration, the
monitoring technology, worker preferences and the generosity of the welfare system. I
propose a theoretical framework where benefits, wage taxes, the job search requirement,
the monitoring intensity and the size of a benefit sanction are endogenously chosen by
the planner for each period of unemployment. I allow for arbitrary ex-ante heterogeneity
in reemployment wages and job finding probabilities as well as for dependence of
these key parameters on unemployment duration. I find that the optimal sanction is
in the majority of cases a temporary cut in benefits to zero, i.e. full suspension of benefits.
The optimal monitoring intensity increases as the returns to search deteriorate
with falling reemployment wages and job finding rates during unemployment in order
to restore search incentives. It also increases with the generosity of the welfare system
because monitoring can be used to offset some of the disincentives to search implied by
more generous benefit payments. I also demonstrate how very informative and large
data can be used to considerably improve and extend the insights that can be obtained
from numerically solving and simulating economic models. I propose and apply a new
method that allows quantifying the impact of implementing the optimal policy on the
job finding probabilities. I find that the optimal policy implies considerably higher job
finding rates than the actual policy, especially for low-skilled workers.