Chapter one studies the effects of moral hazard on employment and wage dynamics. I build a continuous-time competitive search model with aggregate productivity shocks. Due to unobservable idiosyncratic shocks, employers need to design dynamic optimal contract to incentivize workers to exert efforts. To quantify the magnitude of the underlying information friction, the model is calibrated to match the volatility of individual worker’s wage residual in PSID, which corresponding to wage movements that cannot be accounted by observables. I show that the unemployment rate volatility is 2-6 times larger than the case where the moral hazard problem is absent. Meanwhile, the model endogenously generates counter-cyclical wage dispersion. These findings are due to the following novel chan...[ Read more ]

Chapter one studies the effects of moral hazard on employment and wage dynamics. I build a continuous-time competitive search model with aggregate productivity shocks. Due to unobservable idiosyncratic shocks, employers need to design dynamic optimal contract to incentivize workers to exert efforts. To quantify the magnitude of the underlying information friction, the model is calibrated to match the volatility of individual worker’s wage residual in PSID, which corresponding to wage movements that cannot be accounted by observables. I show that the unemployment rate volatility is 2-6 times larger than the case where the moral hazard problem is absent. Meanwhile, the model endogenously generates counter-cyclical wage dispersion. These findings are due to the following novel channel: a higher aggregate productivity reduces the importance of unobservable idiosyncratic shocks, which makes shirking easier to be detected. With a relaxed incentive constraint, firms are more willing to post vacancy, and have less need to expose workers to risk.

Chapter two develops a general framework to study the role of production networks in self-fulfilling business cycles. We build a continuous-time multi-sector business cycle model with input-output linkages and working capital constraints. Due to imperfect contract enforcement, productive firms face credit constraints. Expected drop in firm value tightens constraints and further depresses equity value, generating financial multiplier and thus self-fulfilling business cycles. Theoretically, we derive that financial multiplier nests the input-output multiplier. In the numerical example, we show that intermediate input share impacts indeterminacy through “size effect” and “diluting effect”, whereas the joint effect on economy-wise financial multiplier is U-shaped. Similarly, the network structure has important but ambiguous impact on indeterminacy. Besides, tightening credit constraint in sectors with higher Domar weights in the production network more likely leads to self-fulfilling equilibrium.