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Author Info
Bhattacharya, Joydeep
Chakraborty, Shankha

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Abstract

Researchers have incorporated labor or credit market frictions in isolation within simple neoclassical models to open up a role for institutions, inject realism into their models and examine the impact of these distortions on output and employment. We present an overlapping generations model with production in which a labor market friction (moral hazard) coexists with a credit market friction (costly state verification). The simultaneous presence and interaction of these two frictions is studied. Our main results are: (i) while credit market frictions affect real activity and employment both in the short and long run, labor market frictions typically have only short-run effects unless they also affect the volume of investment per worker, (ii) the two frictions amplify each other to produce higher long-run unemployment than would result from only labor market frictions, (iii) these distortions have the ability to prolong the effect of temporary shocks, and (iv) the dynamical properties of economies with both frictions are, somewhat surprisingly, qualitatively similar to their frictionless counterparts.

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Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 10254.

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Date of creation: 27 Mar 2003
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Publication status: Published in Economic Theory, October 2005, Vol. 26, No. 3, pp. 651-675.
Handle: RePEc:isu:genres:10254

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
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Related research
Keywords: Moral hazard; Costly state verification; Contracts; Dynamics ; Growth models.;

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E0 - Macroeconomics and Monetary Economics - - General

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References listed on IDEAS
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Patricia Crifo & Hind Sami, 2008. "Entrepreneurship, technological change and endogenous returns to ability," Post-Print hal-00243037_v1, HAL. [Downloadable!]
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