"Frictions in Financial and Labor Markets": A Summary of the 35th Annual Economic Policy Conference

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This article contains synopses of the papers presented at the 35th Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis held October 21-22, 2010. The conference theme was "Frictions in Financial and Labor Markets." Leading participants in this field presented their research and commentary.

Federal Reserve Bank of St. Louis Review, July/August 2011, 93(4), pp. 273-92.

The Thirty-Fifth Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis was held October 21-22, 2010. The papers presented at the conference covered a variety of approaches and topics within the general theme of frictions in financial and labor markets. One group of papers directly addresses the question of the impact of frictions in financial markets--defined as a departure from the complete market, perfectly competitive Arrow-Debreu equilibrium--on economic performance. In "Quantifying the Impact of Financial Development on Economic Development," Greenwood, Sanchez, and Wang study the impact of increases in the relative (to the rest of the economy) efficiency of financial intermediaries in output and total factor productivity (TFP). For a calibrated version of their model they conclude that financial frictions can account for large changes in output and measured TFP. A somewhat different conclusion is reached by Midrigan and Xu in "Finance and Misallocation: Evidence from Plant-Level Data." In that paper, the authors study a different financial friction--a borrowing limit--and find that when the model must match the observed distribution of the growth rate of the output of individual firms, the contribution of market imperfections to TFP is rather small.

In "Middlemen in Limit-Order Markets," Jovanovic and Menkveld analyze the role of middlemen in asset markets who are assumed to have superior information and, hence, potentially improve the allocation of resources as they can "direct" each asset to its best use. They find that, depending on the distribution of information of potential asset traders, the presence of middlemen can either increase or decrease efficiency. They also confront the model with data that are consistent with the introduction of middlemen but their results are ambiguous. The last paper that most directly discusses the role of financial frictions is "Financial Markets and Unemployment," by Monacelli, Quadrini, and Trigari. They study a situation in which firms and workers bargain for wages but the total surplus--the object to be divided--decreases in relation to the amount of debt carried by the firm. They show that, in response to a positive productivity shock, firms will choose to borrow more since this lowers their current surplus and thus the wage demands of their workers.

A second set of papers looks at the role of search frictions in labor and goods markets. In "Joint-Search Theory: New Opportunities and New Frictions," Guler, Guvenen, and Violante consider the employment-search problem of a couple. They show that, in the absence of a market that permits perfect risk-sharing, location decisions and employment decisions are related and, due to the costs of separation from one's partner, some workers would reject job offers that appear to be above their reservation wage. A similar idea--searching for a price in this case--drives the price dispersion results in "Equilibrium Price Dispersion and Rigidity: A New Monetarist Approach," by Head, Liu, Menzio, and Wright. They show that when individuals differ in their ability to search for the lowest price, (i) the optimal pricing policy of a firm involves periods of price stickiness (when average prices are changing) and (ii) price dispersion may occur in equilibrium even when there is no inflation.

Finally, two papers deal with the effect of frictions on income distribution. In "Intergenerational Redistribution in the Great Recession," Glover, Heathcote, Krueger, and Rios-Rull study how a recession--not unlike the recent one in the United States--influences the welfare of different generations. …