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What do Information Frictions do?

  • Joydeep Bhattacharya


    (Iowa State University Economics Department)

  • Shankha Chakraborty


    (University of Oregon Economics Department)

Numerous researchers have incorporated labor or credit market frictions within simple neoclassical models to (i) facilitate quick departures from the Arrow-Debreu world, thereby opening up the role for institutions, (ii) inject some realism into their models, and (iii) explain cross country differences in output and employment. We present an overlapping generations model with production in which a labor market friction (moral hazard) coexists along with a credit market friction (costly state verification). The simultaneous presence and interaction of these two frictions is studied. We show that credit frictions have a multiplier effect on economic activity, by directly affecting investment and indirectly through the unemployment rate. The labor market friction, on the other hand, affects unemployment in the short- and long-run but has only a short-run effect on capital accumulation.

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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2003-4.

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Length: 33
Date of creation: 14 Feb 2003
Date of revision:
Handle: RePEc:ore:uoecwp:2003-4
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