What do Information Frictions do?

Joydeep Bhattacharya, Shankha Chakraborty
2003 Social Science Research Network  
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
more » ... on (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.
doi:10.2139/ssrn.383541 fatcat:odv7pqnglffbjbhj3v3kylxjma