Unemployment benefits, contract length and nominal wage flexibility

In a bargaining model, we show that a decrease in the unemployment benefit level increases not only equilibrium employment, but also nominal wage flexibility, and thus reduces employment variations in the case of nominal shocks. Long-term wage contracts lead to higher expected real wages and hence higher expected unemployment than short-term contracts. Therefore, a decrease in the benefit level reduces the expected utility gross of contract costs of a union member more with long-term than with short-term contracts, thereby creating an incentive for shorter contracts. Incentives for employers are shown to change in the same direction.