Incomplete Labor Markets

In this paper, I explore the properties of incomplete labor markets models. These models drop the usual equilibrium restriction that households optimally choose their level of labor supply, and treat the real interest rate as exogenous. I show that in incomplete labor markets models with overlapping generations or credit constraints, a fall in the price of land generates an inefficient decline in employment if the real interest rate remains constant. The low employment means that, in these kinds of models, declines in the real interest rate or debt-financed increases in government spending are Pareto improving.

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