The Macroeconomic Impact of Flexible Labour Contracts: An Application to Spain

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