Financial frictions, information constraints, and labor market inefficiencies: A macro-financial perspective

Abstract

This paper develops a continuous-time search-and-matching model that integrates two key labor market frictions—imperfect information and financial constraints—into the Diamond-Mortensen-Pissarides framework. By endogenizing these frictions, we offer a new explanation for persistent unemployment, asymmetric recoveries, and endogenous hysteresis. The model shows how informational distortions and liquidity constraints jointly suppress search effort and vacancy posting, leading to nonlinear dynamics and friction-induced thresholds, where temporary shocks have lasting effects. We derive closed-form expressions for job-finding rates, market tightness, and steady-state unemployment as functions of these frictions. Empirical extensions demonstrate how compounded constraints affect low-skilled workers, how frictions evolve with unemployment duration, and how macroeconomic shocks amplify scarring through feedback loops. Policy analysis suggests that targeting both worker- and firm-side frictions, through interventions like digital matching tools, liquidity support, hiring subsidies, and credit access, is essential for reducing unemployment persistence and recovery asymmetries. This approach provides a tractable framework for understanding labor market inefficiencies.