What Do Information Frictions Do?

33 Pages Posted: 4 May 2003

See all articles by Joydeep Bhattacharya

Joydeep Bhattacharya

Iowa State University - Department of Economics

Shankha Chakraborty

University of Oregon - Department of Economics

Date Written: February 2003

Abstract

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.

Keywords: costly state verification, efficiency wages, dynamics, frictions

JEL Classification: E1, E6

Suggested Citation

Bhattacharya, Joydeep and Chakraborty, Shankha, What Do Information Frictions Do? (February 2003). Available at SSRN: https://ssrn.com/abstract=383541 or http://dx.doi.org/10.2139/ssrn.383541

Joydeep Bhattacharya (Contact Author)

Iowa State University - Department of Economics ( email )

260 Heady Hall
Ames, IA 50011
United States
515-294-5886 (Phone)
515-294-0221 (Fax)

Shankha Chakraborty

University of Oregon - Department of Economics ( email )

Eugene, OR 97403
United States
541-346-4678 (Phone)