The macroeconomic impact of flexible labor contracts, with an application to Spain

This paper constructs a theoretical model to study the effects on employment of the introduction of flexible labor contracts (i.e., with low firing costs), which occurred in many European countries in the 1980s, and tests it with Spanish data. The model predicts that these contracts increase the size of employment's response to aggregate shocks, while decreasing its persistence. Also, at the time these contracts are introduced, employment overshoots its long-run level. An econometric estimation of labor demand with a panel of large Spanish industrial firms validates several of the model's implications, in particular the increase in employment's cyclical response.