Macroeconomic Stability and Wage Inequality: A Model with Credit and Labor Market Frictions
While macroeconomic volatility in the US economy decreased since the early 1980's, individual earnings volatility and wage inequality increased. This paper argues that increasing financial development can contribute to both changes. I develop a real business cycle model with sectoral productivity shocks and labor as well as credit market frictions. Credit market frictions take the form of collateral-based credit constraints. It is shown that there are interactions between the labor and the credit market that matter for the development of wages and output. When workers are not perfectly mobile between sectors, financial development comes along with an increase in the volatility of individual earnings and in wage inequality, although aggregate output volatility is lower.
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