The dynamics of working hours and wages under implicit contracts

Abstract

In this paper, we explore the dynamics of working hours and 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. Without any 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.