There exists a large literature analyzing the effects of search frictions in the labor market. In this literature, firms are typically modeled in a parsimonious way, with exogenous output per worker. In particular, agency problems between workers and firms are ignored. The focus is thus solely on the effects of search frictions on the flows into and out of employment.
In the present paper, we allow a firm’s output to depend on the wage contracts firms offer their workers. A worker’s output depends on both her effort and a match-specific component. The firm observes total output, but cannot disentangle output into its different components. The firm acts as a principal and chooses a wage contract that maximizes profits given the information constraints. Our aim is to analyze the interplay between search frictions in the market place and agency problems created by workers’ private information. The search frictions and agency problems interact through the amount of "rents" that accrue to the worker.
The excess volatility puzzle (Shiller, 1981, and LeRoy and Porter, 1981) and the equity premium puzzle (Mehra and Prescott, 1985) are two fundamental challenges to theoretical models that have been developed in the finance and macroeconomics literature. Building a production economy model that would satisfactorily account for both high aggregate stock market volatility and the behavior of aggregate quantities has proven to be difficult and no consensus model has arisen. In this paper we build a model in which variations in firms’ ability to raise external capital to take profitable projects lead to asset price volatility. We calibrate the model to the U.S. data and find that it generates about 80% of the observed aggregate stock market volatility. At the same time, the model generates time-series properties of aggregate quantities that match the macroeconomic data.
Our model closely resembles the model described in Kiyotaki and Moore (2008). It is a dynamic stochastic general equilibrium model with heterogeneous entrepreneurs, who face a real and a financial friction. The real friction restricts entrepreneurs’ access to new projects. In every period only a fraction of entrepreneurs find new profitable projects. Following the literature, we assume that the arrival of profitable projects is i.i.d. over time and over entrepreneurs, see e.g. Angeletos (2007) and Kocherlakota (2009). We model an entrepreneur’s ability to start a profitable project as his ability to produce new capital goods one-to-one from the general consumption good. Entrepreneurs who cannot produce capital are willing to buy claims to returns of other entrepreneurs’ projects to replace their depreciated capital. We call these claims equity. Markets are incomplete and equity is the only financial asset that is traded in the economy. The financial friction restricts new issuance of equity. We assume that entrepreneurs can only leverage a fraction of the returns of the newly produced capital, i.e. sell only a fraction of the new project as equity. On its own, this friction is standard in the literature. The novel feature of our model is that the ratio of outside to total financing of projects changes over time.
The global economic landscape has shifted dramatically since the mid-1980s. First, there has been a rapid increase in trade and financial linkages across countries. Second, emerging market economies have increasingly become major players and they now account for about a quarter of world output and a major share of global growth. These developments, along with the imminent U.S. recession and concerns about its international spillover effects, have generated a vigorous debate about changes in the patterns of international business cycle comovement. On the one hand, the conventional wisdom suggests that the forces of globalization in recent decades have increased cross-border economic interdependence and led to convergence of business cycle fluctuations. Greater openness to trade and financial flows should make economies more sensitive to external shocks and increase comovement in response to global shocks by widening the channels for these shocks to spill over across countries.
On the other hand, in recent years the impressive growth performance of emerging market economies, especially China and India, seems to have been unaffected by growth slowdowns in a number of industrial countries. This has led to questions about the potency of international channels of business cycle transmission. Some observers have even conjectured that these emerging markets have “decoupled” from industrial economies, in the sense that their business cycle dynamics are no longer tightly linked to industrial country business cycles. These two views of cross-border interdependence have very different implications for the evolution of global business cycles.
