Labor Contract, Asymmetric Information and Business Cycles

In this paper, a heterogeneous agent model of workers and employers is developed with differing information structures. In particular, the static implicit contract is introduced into otherwise standard dynamic equilibrium business cycle model by embedding the state-contingent wage-hour outcomes from the labor contract with the firm's capital accumulation decision. With this model, it is discussed whether this model's implications are different from those of standard general equilibrium business cycle model and implicit contract model. Compared to the prototype general equilibrium model, the labor contract feature, especially under asymmetric information, improves the predictions for the relative fluctuation and the correlation between hours and real wages. On the other hand, the dynamic general equilibrium consideration also help to overturn the unsatisfactory features in the previous contract theory.