Early Contract Renegotiation: An Analysis of U.S. Labor Contracts from 1970 to 1995

Abstract

Abstract This paper examines the ex post flexibility of U.S. labor contracts during the 1970-95period by investigating whether unanticipated changes in inflation increase the likelihoodof a contract being renegotiated prior to its expiration. We find strong empirical supportfor this hypothesis. Specifically, our results indicate that renegotiations are triggeredprincipally by large and infrequent price shocks of either sign. When combined withevidence that ex ante contract durations are shorter during episodes of increased inflationuncertainty, our results suggest that these contracts are flexible both ex ante and ex post tochanges in the evolution of inflation. Key words: labor contract, early renegotiation Rich, Tracy: Federal Reserve Bank of New York (e-mail: robert.rich@ny.frb.org,joseph.tracy@ny.frb.org). The authors thank Evan LeFlore for excellent research assistance andLeif Danziger for helpful comments. The views expressed in this paper are those of the authorsand do not necessarily reflect the position of the Federal Reserve Bank of New York or the FederalReserve System.