Economic Development and the Equilibrium Interaction of Financial Frictions
Publication Type:Working Papers
Motivated by evidence from the micro data that the type of financial frictions faced by individuals varies across regions within countries, we develop a general equilibrium framework with heterogeneous producers that encompasses different micro financial underpinnings. We study the macroeconomic implications of a moral hazard problem due to unobserved effort and contrast them with those of limited commitment, the friction studied in most of the existing literature. The effects of moral hazard on macroeconomic aggregates – in particular aggregate productivity and the equilibrium interest rate – differ dramatically from those of limited commitment, and also from partial equilibrium effects of moral hazard. We then study an economy with different frictions in different regions or sectors. The combined effect of moral hazard and limited commitment is more than just a linear combination of their individual effects, and furthermore gives rise to interregional capital and labor flows that resemble rural-urban patterns observed in the data. Our overall conclusion is that different financial frictions not only have different macroeconomic effects but also interact in unexpected ways.
Topic:Flow of Funds