Seminar Papers,
Stockholm University, Institute for International Economic Studies

Abstract: We show in a union-bargaining model that a decrease in the unemployment benefit level increases not only equilibrium employment, but also nominal wage flexibility, and thus reduces employment variations in the case of nominal shocks. Long-term wage contracts lead to higher expected real wages and hence higher expected unemployment than short-term contracts. Therefore lower benefits reduce the expected utility gross of contract costs of a union member more with long-term than with short-term contracts and thus create an incentive for shorter contracts. Incentives for employers work in the same direction. Lower taxes associated with lower benefits also tend to make short-term contracts more attractive.

Keywords: nominal wage flexibility; contract length; macroeconomic fluctuations; unemployment benefits.

JEL-codes: E24; E32; J64; J65

43 pages, May 15, 2001

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