Flexible Contracts as Business Cycle Stabilizers

In this paper, I provide a novel insight for understanding the role of flexible contracts in the economy. I draw upon Dutch data to show that the availability of flexible jobs over the business cycle largely influences the unemployment risk of permanent workers. Motivated by the empirical evidence, I build a New Keynesian model in which permanent and flexible jobs coexist. I argue that the interaction between incomplete markets and the endogeneity of labor market transitions generates an important macroeconomic-stabilization hedging role for flexible contracts. However, this comes at a cost to flexible workers in terms of employment fluctuations, resulting in a non-monotonic relationship between welfare and the share of flexible contracts in the economy. My results have important policy implications for a wide range of developed countries that pursue flexicurity through dual labor markets.