Essays on labor market frictions and international finance

Abstract

This dissertation is a collection of essays focusing on a broad sense Macroeconomics. Through its two chapters, this thesis reviews topics in labor and credit market frictions, capital-embodied technological change, as well as, non-homothetic preferences in small open economies with downward nominal wage rigidities. In chapter 1, we revisited the shock-institution hypothesis of long-run unemployment. Through the chapter we find that heterogeneous long-run unemployment trajectories can be accounted for a common technological shock that is propagated differently by differences in the credit market functioning. We present empirical evidence that motivates the relationship between the three key ingredients of the model: labor market frictions, credit market frictions and capital embodied technical change. Frictions are modeled as in the Diamond-Mortensen-Pisarides framework and unemployment is the composite of two terms, the unemployment duration and unemployment incidence, both of which depend on credit market performance. The key implication of the model is that economies with a worse credit market absorbs the technological shock mainly through the labor market tightness, primarily affecting the unemployment duration. Moreover, the higher the credit market frictions the higher the wage inequality, and more heterogeneous the vintage technology distribution which affect the output of the economy. In chapter 2, I analyze the effects of non-homothetic preferences in a small open economy with nominal frictions in the labor market. I present a standard small open economy model with two sectors, tradable and non-tradable, and whose friction is represented by downward nominal wage rigidity. I extend this environment with non-homothetic preferences to study how heterogeneous income elasticity among goods affect the policy response in a boom-bust cycle of consumption. Non-homothetic preferences ensure that the marginal rate of substitution depends on the level of total consumption in addition to allowing the analysis of income effects. Both features are especially important for the study of cycle and financial crises. This chapter shows theoretically and quantitatively an amplification of the boom-bust cycle in a non-homothetic economy. This amplification in turn, forces stronger policy responses to partially offset the adverse effects of the cycle. The underlying mechanisms is the greater use of debt in the non-homothetic economy to allocate consumption between sectors, not only during the cycle but also in the long term.