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The Labor Market Consequences of Adverse Financial Shocks

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  • Boeri, Tito

    ()
    (Bocconi University)

  • Garibaldi, Pietro

    ()
    (University of Turin)

  • Moen, Espen R.

    ()
    (Norwegian Business School (BI))

Abstract

The recent financial crises, alongside a dramatic rise in unemployment on both sides of the Atlantic, suggest that financial shocks do translate into the labor markets. In this paper we first document that financial recessions amplify labor market volatility and Okun's elasticity over the business cycle. Second, we highlight a key mechanism linking financial shocks to job destruction, presenting and solving a simple model of labor market search and endogenous finance. While finance increases job creation and net output in normal times, it also augments their aggregate response in the aftermath of a financial shock. Third, we present evidence coherent with the idea that more leveraged sectors experience larger employment volatility during financial recessions. Theoretically, the job destruction effect of finance works as follows. Leveraged firms may find themselves in a position in which their liquidity is suddenly called back by the lender. This has direct consequences on a firm ability to run and manage existing jobs. As a result, firms may be obliged to shut down part of their operations and destroy existing jobs. We argue that with well-developed capital markets, firms will have an incentive to rely more on liquidity, and in normal times deep capital markets lead to tight labor markets. After an adverse liquidity shock, firms that rely much on liquidity are hit disproportionally hard. This may explain why the unemployment rate in the US during the Great Recession increased more than in European countries experiencing larger output losses. Empirically, the paper uses a variety of datasets to test the implications of the model. At first we identify crises that, just like in the model, caused a sudden reduction of liquidity to firms. Next we draw on sector-level data on employment and leverage in a number of OECD countries at quarterly frequencies to assess whether highly leveraged equilibria originate more employment adjustment under financial recessions. We find that highly leveraged sectors and periods are associated with higher employment- to-output elasticities during banking crises and this effect explains the observation of higher Okun's elasticities during financial recessions. We also argue that the effect of leverage on employment adjustment can be interpreted as a causal effect, if our identification assumptions are considered plausible. All this amounts essentially for a test of the labor demand channel of adjustment.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 6826.

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Length: 26 pages
Date of creation: Aug 2012
Date of revision:
Handle: RePEc:iza:izadps:dp6826

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Keywords: financial shocks; matching; Okun's elasticities;

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  1. Donatella Gatti & Christophe Rault & Anne-Gael Vaubourg, 2009. "Unemployment and Finance: How do Financial and Labour Market Factors Interact?," CESifo Working Paper Series 2901, CESifo Group Munich.
  2. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," CEMA Working Papers, China Economics and Management Academy, Central University of Finance and Economics 595, China Economics and Management Academy, Central University of Finance and Economics.
  3. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "Is the 2007 US Sub-prime Financial Crisis So Different? An International Historical Comparison," American Economic Review, American Economic Association, American Economic Association, vol. 98(2), pages 339-44, May.
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Cited by:
  1. Bernal-Verdugo, Lorenzo E. & Furceri, Davide & Guillaume, Dominique, 2013. "Banking crises, labor reforms, and unemployment," Journal of Comparative Economics, Elsevier, vol. 41(4), pages 1202-1219.
  2. HOSONO Kaoru & TAKIZAWA Miho & TSURU Kotaro, 2014. "The Impact of a Demand Shock on the Employment of Temporary Agency Workers: Evidence from Japan during the global financial crisis," Discussion papers, Research Institute of Economy, Trade and Industry (RIETI) 14046, Research Institute of Economy, Trade and Industry (RIETI).

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