Credit market imperfection, labor supply complementarity, and output volatility

This paper argues that output volatility depends on the degree of credit market imperfection. In the early stages\r\nof financial development, agents are constrained in their borrowing ability. As a result, the individual savings,\r\naffected by the labor supply, play a dual role in the economy, having repercussions on the interest rate. On the\r\none hand, high savings imply high investment, low marginal product of capital and thus low interest rate. On\r\nthe other hand, high savings affect the agents' ability to run highly productive investment projects, which\r\nincreases the interest rate.When the former effect is dominant, a dynamic complementarity between individual\r\nand aggregate labor supply arises. This leads to a local and global indeterminacy of equilibrium paths. If the\r\nborrowing constraint is relaxed, the complementarity between individual and aggregate labor supply decisions\r\nweakens, equilibrium becomes globally unique and the possibility of having aggregate fluctuations in\r\noutput disappears.