Fluctuations in a Dual Labor Market

I build a New-Keynesian dynamic stochastic general-equilibrium model with a dual labor market. Firms and workers meet through a matching technology à-la Diamond-Mortensen-Pissarides and face a trade-off between productivity and flexibility at the hiring stage. All else equal, open-ended contracts are more productive than fixed-term contracts, but they embed a firing cost. The share of fixed-term contracts in job creation fluctuates endogenously, which enables to assess the resort to temporary contracts along the cycle and its response to different shocks. I estimate the model using a first-order perturbation method and classic Bayesian procedures with macroeconomic data from the Euro area. I find that the share of fixed-term contracts in job creation is counter-cyclical. The agents react to shocks essentially through the job creation margin and the contractual composition of the hires. Moreover, a general-equilibrium effect arises ; the substitution between fixed-term and open-ended contracts at the hiring stage influences the job seekers' stock, which in turn impacts job creation. Using my previous estimates and solving the model with a third-order perturbation method, I find that fixed-term employment reacts to negative aggregate demand shocks and uncertainty shocks oppositely. This result suggests that fixed-term employment could be used to identify uncertainty shocks in future research. As for inflation, changes in firing costs do not alter its dynamics as long as open-ended and fixed-term matches do not differ much in productivity all else equal.