Business Cycle Implications of Incomplete Markets Models

Ester Faia and Ekaterina Shabalina

No 20297, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We assess the business cycle properties for a large set of incomplete market models with (or without) nominal and real rigidities: they are similar to those from representative and two-agent economies, both fall short of matching empirical labour market dynamic. This is true even when we consider counter-cyclical income risk, which gives implausibly high wage volatility. Augmenting the incomplete market model with heterogenous indivisible labour supply, due to discrete choices, reconciles low micro elasticities and large employment fluctuations and dampens wage volatility, more so with wage rigidity.

Date: 2025-05
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