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Credit market imperfection, labor supply complementarity, and output volatility

Anna Agliari () and George Vachadze ()

Economic Modelling, 2014, vol. 38, issue C, 45-56

Abstract: This paper argues that output volatility depends on the degree of credit market imperfection. In the early stages of financial development, agents are constrained in their borrowing ability. As a result, the individual savings, affected by the labor supply, play a dual role in the economy, having repercussions on the interest rate. On the one hand, high savings imply high investment, low marginal product of capital and thus low interest rate. On the other hand, high savings affect the agents' ability to run highly productive investment projects, which increases the interest rate. When the former effect is dominant, a dynamic complementarity between individual and aggregate labor supply arises. This leads to a local and global indeterminacy of equilibrium paths. If the borrowing constraint is relaxed, the complementarity between individual and aggregate labor supply decisions weakens, equilibrium becomes globally unique and the possibility of having aggregate fluctuations in output disappears.

Keywords: Borrowing constraint; Credit cycles; Elastic labor supply; Endogenous fluctuations; Output volatility (search for similar items in EconPapers)
JEL-codes: E32 E44 O16 (search for similar items in EconPapers)
Date: 2014
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DOI: 10.1016/j.econmod.2013.10.039

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