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Wage Rigidity, Implicit Contracts, Unemployment and Economic Efficiency

David M Newbery () and Joseph Stiglitz

Economic Journal, 1987, vol. 97, issue 386, 416-30

Abstract: Standard implicit contract theory can explain wage rigidity but not unemployment and pays insufficient attention to the general equilibrium aspects and constraints limiting the set of feasible contracts. Implicit contracts must specify an enforcement mechanism, can only be conditional on observable information, and must be of limited complexity. Without these restrictions contracts generate full employment which is constrained inefficient. Natural restrictions on enforceability or complexity alone do not produce unemployment, though limited observability may. With two or more restrictions unemployment may result. Specifically, periodic unemployment can arise if contracts are of limited complexity and cannot be enforced through third parties. Copyright 1987 by Royal Economic Society.

Date: 1987
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