Fixed-term employment contracts in an equilibrium search model

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Fixed-term employment contracts in an equilibrium search model

Alvarez, Fernando; Veracierto, Marcelo

Journal of economic theory, 09/2012, Volume: 147, Issue: 5

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We develop a theoretical model of firm dynamics and unemployment and characterize equilibria with tenure dependent separation taxes. The model is a version of the Lucas and Prescott island model with undirected search. Two equivalent decentralizations are considered: one with spot labor markets and one with long-term employment relations. We model “temporary contracts” as the special case of a separation tax that only applies to workers with tenure higher than J. While in principle these contracts require a J-dimensional state space, equilibrium allocations solve a simple dynamic programming problem characterized by two-dimensional inaction set(s).

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