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I study the effects of firing costs in an equilibrium model of the labor market with moral hazard. Layoff is an incentive device, modeled as termination of the optimal long-term contract. When the economy’s stock of firms is fixed, firing costs could reduce layoffs and increase worker welfare. In the long run when firms are free to enter and exit the market, firing costs generate not only lower employment, longer unemployment durations, and lower aggregate output, but also lower welfare for both employed workers and new labor market entrants.