Essays on credit constraints, bubbles and unemployment

Chapter 1 introduces endogenous credit constraints in a search model of unemployment.These constraints generate multiple equilibria supported by self-fulfilling beliefs. A stock market bubble exists through a positive feedback loop mechanism. The collapse of the bubble tightens the credit constraints, causing firms to reduce investment and hirings. Unemployed workers are hard to find jobs generating high and persistent unemployment. Chapter 2 documents a hump-shaped empirical relationship between financial development and the national savings rate across 12 East Asian and 31 OECD economies. An incomplete-market model featuring both heterogeneous households and heterogeneous firms is provided to explain this hump-shaped relationship. The key insight of the model is that financial development tends to reduce the precautionary saving incentives of households but increase firms’ ability to borrow and invest. As a result, the aggregate savings rate may rise initially with financial development because of greater investment by firms, but then it declines with further financial development because of substantially reduced precautionary savings by households. The model also predicts that the market interest rate lies substantially below the rate of return to capital in emerging economies, but the gap diminishes with financial development, as observed in the data. Chapter 3 studies the effects of endogenous participation on wage dynamics and hence on the unemployment fluctuations in a search theoretic model. It shows that endogenous participation makes the expected outside options of workers countercyclical, which induces a countercyclical component in the wage equation under Nash bargaining. As a result, the elasticity of wage with respect to productivity becomes smaller and hence the model can generate larger unemployment fluctuations, compared to the textbook model. With careful calibration, I show that the model well capture the wage dynamics and can explain nearly half of the unemployment volatility