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INTRODUCTION
In recent papers by Baily (1974), D. F. Gordon (1974) and Azariadis (1975) it has beenproposed that labour market transactions can be viewed as typically (implicit) contractual arrangements between risk averse employees and less risk averse employers. Their contributions suggest that the employers, in these contracts, "insure" their employees by paying them wage rates with small variations over the states of nature; in return, the employers are compensated for their " gamble" by premia in the form of lower average wages (the average being taken over states of nature) which workers are implicitly willing to pay for such wage insurance. Although both Azariadis and Baily have been cautious about drawing macro-economic implications from sticky wages in their models, subsequent proponents of indexed labour contracts argue that the risk-shifting aspects of implicit contracts may successfully account for the non-neutrality of monetary policies on aggregate output and employment. (See for example Gray (1976), (1978), Poole (1976) and Fischer (1977).) Because unemployment in many Keynesian macro-models is caused by rigid wages, by a parallel argument it has been held that the smoothing of wages caused by implicit contracts results in non-Walrasian fluctuations in employment. The present paper questions this last claim on unemployment; for it is demonstrated here, if workers can (implicitly) make contracts with the firm, they can also readily insure against employment variations (i.e. layoffs) and, as a result, implicit contracts even with sticky wages will lead to full employment, in most instances, rather than to unemployment. To outline our logic, suppose that there is an implicit contract whereby in a state of the world s a firm employs n1 workers at a wage w but lays off n2 workers, each worker randomly being laid off with the same probability n2/(n1 +n2). First observe that a risk averse employee would prefer, ex ante, a contract which guaranteed him employment in state s at the wage wnI/(nI +Jn2) to the lottery of receiving w with probability n1/(n1 +n2) and 0 with probability n2/(n1 +n2).Secondly, note that the firm would be indifferent between this employment-guaranteeing contract and the layoff contract since its wage bill is unchanged at wnl. These two observations (together with the assumed continuity of the worker's preferences) imply the existence of a wage rate w* such that (i) w* < wjnj/(n1 + n2) and (ii) the worker strictly prefers guaranteed employment a...
