Abstract
How will the commitment to price stability affect labour market rigidities in the European Monetary Union? I explore a model where firms choose between fixed wage contracts (where the employer cannot lay off the worker, and the wage can only be changed by mutual consent), or contracts where employment is at will, so that either party may terminate employment (with strong similarities to temporary jobs). A fixed wage contract provides better incentives for investment and training, while employment at will facilitates efficient mobility. Inflation erodes the real value of a fixed contract wage over time, and badly matched workers are more likely to quit for other jobs. Disinflation has opposing effects on labour market rigidity: fixed wage contracts become more rigid in real terms, but fewer firms will choose fixed wage contracts. Previous versions of the paper have circulated under the title .Labour market rigidities and inflation.. I have benefitted from comments by Karl Ove Moene, Asbjørn Rødseth, Lucy White, and participants at presentations at the University of Oslo, CODE University of Barcelona, and the Norwegian School of Management, and from a discussion with Larry Katz. I am grateful for the hospitality of NBER, where part of this paper was written.