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Labor Market Dynamics under Long Term Wage Contracting

  • Leena Rudanko

This paper introduces risk averse workers into a search and matching model and considers the quantitative performance of the model over the business cycle. Wages are determined by long term contracts between workers and firms, with firms providing insurance to workers against variation in labor productivity. The insurance motive delivers endogenous wage rigidity, the extent of which depends on the contracting environment. The quantitative results show that the model has no trouble producing wages that are too rigid relative to data. The key parameter governing how much volatility the model produces not only in unemployment and vacancies but also wages, is the drop in consumption for the unemployed. In addition, explaining the volatility of wages requires that contracting is limited by the ability of both the worker and firm to end the employment relationship unilaterally. These results contrast with Shimer (2005) and Hall (2005), who argue for introducing rigid wages into search and matching models.

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 314.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:314
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  24. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
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  29. Sigouin, Christian, 2004. "Self-enforcing employment contracts and business cycle fluctuations," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 339-373, March.
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