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Federal Reserve Bank of Chicago
Working Paper Series
Fixed term employment contracts in an equilibrium search model
Fernando Alvarez
Marcelo Veracierto

Fixed term employment contracts have been introduced in number of European countries as a way to provide flexibility to economies with high employment protection levels. We introduce these contracts into the equilibrium search model in Alvarez and Veracierto (1999), a version of the Lucas and Prescott island model, adapted to have undirected search and variable labor force participation. We model a contract of length J as a tax on separations of workers with tenure higher than J. We show a version of the welfare theorems, and characterize the efficient allocations. This requires solving a control problem, whose solution is characterized by two dimensional inaction sets. For J = 1 these 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 evaluate to what extent contract lengths similar to those observed in Europe, close the gap between these two extremes.

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Fernando Alvarez & Marcelo Veracierto, Fixed term employment contracts in an equilibrium search model, Federal Reserve Bank of Chicago, Working Paper Series WP-05-14, 2005.
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Keywords: Labor contract ; Employment (Economic theory)
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