Long-Term Contracts as a Strategic Device

24/10/2004 |  Klein Nir
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Welfare Policy and Labor Market

Long-Term Contracts as a Strategic Device
Nir Klein

Abstract

This paper shows that in a two-sector labor market, union choice between short and long-term nominal-wage contracts involves a trade-off between expected levels of inflation and unemployment and their variability. On the one hand, if the union sets long-term contracts, it can affect (future) competitive-sector wage contracts through its impact on inflationary expectations, and as a result it can achieve lower expected levels of inflation and unemployment. On the other hand, because long-term contracts introduce uncertainty regarding future productivity shocks, this alternative may lead to variability in inflation and unemployment from the union's perspective. This framework also evaluates the effect of union density on union choice. The analysis indicates that lower union density may lead to long-term contracts at low degree of central bank conservatism, and to short-term contracts at high degree of central bank conservatism.

Keywords: Contract length, labor market, union density, central bank conservatism

JEL Classifications: E50, E58, J50, J51.

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