The Economics of Imperfect Markets

This paper examines the relative magnitude of financial versus real frictions by looking at how firms react to quasi-exogenous cash shortfalls to pension assets. To answer the question theoretically, we examine a dynamic model of financing and exogenous cash shortfalls. We find that when financing costs are high, firms adjust on real margins and vice versa. We find that firms optimally avoid costly cash shortfalls, only experiencing these events after serious negative shocks to profits. We also find that commonly used regression tests for the presence of finance constraints can produce false positives. In contrast, regression discontinuity techniques can provide an accurate method for uncovering the existence and magnitudes of finance constraints.

In this paper we evaluate the empirical importance of the contemporaneous presence of financial and labor market imperfections by studying cross-country differences in market valuations of listed companies and firms’ cash holdings. Our results show that, as expected, financial market imperfections are positively correlated with firms’ cash holdings and that the latter are larger wherever employment protection laws (EPL) are stricter. Moreover, stock markets value liquid companies less in economies with higher EPL levels.

Based on a matched sample of Japanese small firms and main banks we investigate the bank-firm relationships in the early 2000s. We obtain new findings. First, even small firms with a main bank relation have multiple bank relationships. Second, firms tied with a financially weak main bank increase the number of bank relations. Third, longer duration of a main bank relation increases the number of bank relations. Moreover we find that firms with fewer bank relations pledge personal guarantees to their main banks and are charged a higher interest rate. This suggests that firms take actions against the monopoly power of a main bank.

The paper presents a model where fixed assets play a role in reducing credit rationing. The basic idea is that when loans are collateralized and firms are credit constrained, the amount borrowed is generated by the value of the collateral. I use a classical credit rationing model to explain the link between firms’ debt capacities and asset value in the case of distress. As we shall see, the price of fixed assets depends on whether there are firms that repurchase them. In fact, it depends on the number of bad firms in the economy as well as on the liquidity of good firms. In this model, a separating equilibrium can only occur if there exist a number of bad firms that go bankrupt and if there exist good firms with sufficient liquidity. Each firm derives positive externalities from the existence of other firms. Indeed, the optimal leverage of firms depends on the possibility of repurchasing the distressed assets.

In a seminal article, Levine et al. (2000) provide cross-sectional evidence showing that financial development has positive average impact on long-run growth, using a sample of 71 countries. We argue that the evidence is sensitive to the presence of outliers.

This paper analyzes the effect of institutional structure, regulations, technological progress, and labor market flexibility on productivity in the Italian economy within the framework of the representative agent model of Saltari and Travaglini (2007). The core model is shown to be too restrictive to provide a good representation of the Italian economy. Broadening the view of the way in which firms take account of the costs of changing the labor force and investment achieves a more satisfactory representation of the dynamics of the productive sector of the economy while still retaining the spirit of the core model. Institutional or market structures, regulations, and other factors are incorporated in the system through modifications to the production function, the demand and supply functions for labor. A full-information, Gaussian estimator of a differential equation system is used throughout. As the constraints on the system arise from both macro-economic theory and the institutional structure of the Italian economy, this estimator provides a much more stringent test of all the hypotheses embedded in the model than many other studies. The model provides a foundation for a study of the extent to which, over time, changes in regulations or market structure might allow firms to reallocate resources to take better advantage of the skills available in the labor force within the context of a segmented labor market with varying efficiencies. The model lends itself to a policy analysis of the effects of these changes on the workings of the labor market as the ease with which firms may change their labor force determine the dynamics of the interaction between firms and labor and the path over time of labor and capital themselves.

Starting with Wicksell and until the heyday of Keynesian economics, inflation, unemployment and business cycles were thought and taught mainly as problems originating from “saving-investment imbalances” due to some form of malfunctioning of the capital market. Whereas modern studies of imperfect capital markets have greatly improved our understanding of capital market failures, their impact on macroeconomics has remained surprisingly limited. The macroeconomic consequences of saving-investment imbalances are still undeveloped in this literature. The most popular macroeconomic model to date – the so-called New Neoclassical Synthesis – dispenses with capital market imperfections altogether. The aim of this paper is to fill this gap. After an overview of the historical foundations and the current state of the macroeconomics of imperfect capital markets, the paper presents a competitive, flex-price model of saving-investment imbalances where deviations of the market interest rate from the Wicksellian natural rate generate (disequilibrium) business cycles. Then the model is extended to make the market interest rate endogenous and to allow preliminary considerations to be made about monetary policy and the control of the interest rate over the business cycle.

This paper explores a two-country DSGE model with sticky prices à la Calvo (1983) and local-currency pricing. We analyze the investment decision in the presence of adjustment costs of two types, i.e., capital adjustment costs (CAC) and investment adjustment costs (IAC). We compare the investment and trade patterns with adjustment costs against those of a model without adjustment costs and with (quasi-) flexible prices. We show that having adjustment costs results into more volatile consumption and net exports series, and less volatile investment. We document three important facts on US trade dynamics: (1) the S-shaped cross-correlation between real GDP and the real net exports share, (2) the J-curve between terms of trade and net exports, and (3) the weak and S-shaped cross-correlation between real GDP and terms of trade. We find that adding adjustment costs tends to reduce the model’s ability to match these stylized facts. Nominal rigidities cannot account for these features either.

Few scholars have seriously considered the possibility that the very existence of an antitrust law might make markets less competitive. In this chapter, we provide a selective review of this thought-provoking literature. The focus of our analysis is on contributions within the limits of the neo-classical theory of firms and markets, pointing out that antitrust legislation can hinder price/output competition. Following this literature, the introduction of antitrust penalties or leniency programmes can have the perverse effect of stabilizing cartels and increasing their size, as these policies may raise the costs of deviating and/or renegotiating a collusive agreement.