Labor Contracts and Business Cycles
This paper investigates the claim that real business cycle models perform poorly in matching real-world aggregate labor market behavior because observed real wage payments do not correspond to the actual marginal productivity of labor but contain an insurance component not accounted for by the Walrasian pricing mechanism. We introduce contractual arrangements between employees and employers and use the theory of optimal contracts to derive an equilibrium relation between aggregate states of the we economy and wage-labor outcomes. This contractual arrangement is then embedded into a standard one-sector, stochastic neoclassical growth model in order to look at the business cycle implications of the contractual hypothesis. Copyright 1995 by University of Chicago Press.
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