widely discussed in other surveys 24 , the role of search externalities in credit markets has
only recently been recognized. Within this framework, market liquidity depends on the
matching process between borrowers and lenders. This literature suggests that search
frictions in credit markets are particularly useful in the modelling of informal labour
an product markets where informal firms cannot rely on collateral and need to contact
informal moneylenders. Wasmer and Weil (2004) develop a model with credit and labour
market imperfections due to trading frictions in both markets,25 where labour and capital
imperfections are symmetric. Assumptions in this model depart from the traditional
search and matching literature because here entrepreneurs need to finance the search
process and need to find a lender (i.e. a moneylender in the informal credit market) to
start-up a business activity. Likewise, Becsi et al. (2005) model credit market activity
within a search match framework where borrowers are heterogenous. A few other papers
adopt trading frictions in the credit markets (Dell’Ariccia and Garibaldi (2000) among the
others), but to the best of our knowledge, none has explicitly used trading frictions in the
credit market to model the firm’s decision to enter or not the informal sector and trading
frictions in the credit market have not yet been incorporated in a DSGE model. Wasmer
and Weil (2004), by introducing financial imperfections, provide a simple measure of the
financial accelerator based on the idea of a ‘credit gap’: credit market frictions reduce the
number of entrepreneurs discouraged by the lower probability of finding a lender, and in
turn this creates a negative externality by reducing the number of lenders, accelarating
the adverse implications of a contraction in credit. This way credit market imperfections
magnify the negative consequences of economic shocks. The authors show that the excess
return on business loans, i.e. the “credit gap”, depends on the bank’s bargaining power
and on the degree of market imperfections.
5.3 Credit-constrained entrepreneurs, informal credit and labour mar-
kets linkages
In the firm’s choice between operating formally or informally (i.e. intrafirm margin),
access to informal credit markets is often represented as one of the costs of going informal.
This is the approach taken by Straub (2005) where access to formal credit markets and
24See Ghosh et al. (1999).
25The model assumes risk-neutral agents and take the interest/discount rate as given.
24