Equilibrium Unemployment with Incomplete Markets

Lawrence Uren | University of Melbourne

This paper integrates a frictional labour market into a general equilibrium model with incomplete markets. Workers are subject to employment shocks and are able to insure themselves by trading a risk free asset.  Firms seek to maximise profits by hiring workers in a frictional labour market. In equilibrium, the level of unemployment, the interest rate, and output are jointly determined.  Using a continuous time framework, we show the steady state equilibrium is easier to characterise than competing discrete-time models. In particular, we are able to derive a steady state distribution of wealth, consumption and utility in closed form.  The model is then used to examine the role of ex ante heterogeneity in explaining the  distribution of wealth and the role of unemployment benefits on welfare.