The Dynamics of Working Hours and Wages Under Implicit Contracts

In this paper, we explore the dynamics of working hoursand wages in a model economy where a firm and its workforce are linked to each other by an implicit contract. Specifically, we develop a deterministic and a stochastic framework in which the firm sets its level of labor utilization by considering that workers’ earnings tend to adjust in the direction of a fixed level. Withoutany uncertainty about firm’s profitability, we show that the existence and the properties of stationary solutions rely on the factors that usually determine the enforceability of contracts and we demonstrate that wages move countercyclically towards the allocation preferred by the firm. Moreover, we show that adding uncertainty does not overturn the countercyclical pattern of wages but is helpful in explaining their dynamic behavior in response to demand shocks as well as their typical stickiness observed at the macrolevel.

In this paper, we explore the out-of-equilibrium dynamics of working hours and wages in a model economy where workers and firms have agreed upon an implicit contract that smooths long-run consumption. Specifically, we analyse a deterministic and a stochastic framework in which a firm inter-temporally sets its level of labour utilization by considering that workers' earnings tend to adjust in the direction of a fixed level that seeks to stabilize their consumption. Without any uncertainty in labour effectiveness, this theoretical setting may have one, two or no stationary solution. The dynamics of the deterministic economy, however, can be assessed only in the two-solution case and it reveals that wages move counter-cyclically towards the allocation preferred by the firm. Adding uncertainty in labour effectiveness does not overturn the counter-cyclical pattern of wages but is helpful in explaining the wage stickiness observed at the macro level.