Fixed-Term Employment Contracts in an Equilibrium Search Model

73 Pages Posted: 24 Dec 2006 Last revised: 30 Apr 2007

See all articles by Fernando Alvarez

Fernando Alvarez

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Marcelo Veracierto

Federal Reserve Bank of Chicago - Research Department

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Date Written: December 2006

Abstract

This paper analyzes the effects of fixed-term contracts using a version of the Lucas and Prescott island model with undirected search. A fixed-term contract of length J is modeled as a tax on separations of workers with tenure higher than J . While in principle these policies require a very large state space to analyze the firms and households' problems, we show that equilibrium allocations solve a simple dynamic programming problem. Analyzing this problem we show that equilibrium employment dynamics are characterized by two dimensional inaction sets. Finally, to understand the effect of these contracts, we compare them with two extreme cases: for J = 1 the fixed-term contracts are equivalent to the case of firing taxes, and for large J they are equivalent to the laissez-faire case. In a calibrated version of the model, we find that temporary contracts with J equivalent to three years length close about half of the gap between those two extremes.

Suggested Citation

Alvarez, Fernando and Veracierto, Marcelo, Fixed-Term Employment Contracts in an Equilibrium Search Model (December 2006). NBER Working Paper No. w12791, Available at SSRN: https://ssrn.com/abstract=953356

Fernando Alvarez (Contact Author)

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Marcelo Veracierto

Federal Reserve Bank of Chicago - Research Department ( email )

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