Consumption Commitments and Employment Contracts*

We examine an economy in which the cost of consuming some goods can be reduced by making commitments that reduce flexibility. We show that such consumption commitments can induce consumers with riskneutral underlying utility functions to be risk averse over small variations in income, but sometimes to seek risk over large variations. As a result, optimal employment contracts will smooth wages conditional on being employed, but may incorporate a possibility of unemployment. JEL Numbers: D21, D31, D81, J34 *We thank Andy Abel, Jesus Fernandez-Villaverde and Richard Rogerson for helpful conversations and two referees for a number of constructive suggestions. We also thank the National Science Foundation for financial support. Consumption Commitments and Employment Contracts