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Equilibrium Default and Slow Recoveries

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  • Joseph Mullins

    (NYU)

  • Gaston Navarro

    (New York University)

  • Julio Blanco

    (New York University)

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    Abstract

    The 2007-2009 financial crisis generated a striking short-lived increase in the employment separation rate and a persistent decrease in its finding probability, which resulted in an increase in unemployment and a slow recovery. In this paper we propose a novel mechanism that can account for these patterns. The key innovation relies on the interaction between firms' number of workers and its willingness to default: firms with more debt per worker are less likely to repay and consequently face higher credit spreads. Therefore, at the aggregate level, credit conditions worsen with higher unemployment, which further reduces firms' incentives to hire resulting in a loop between the financial and the labor market.

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 694.

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    Date of creation: 2013
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    Handle: RePEc:red:sed013:694

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    1. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
    2. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta-Eksten & Stephen Terry, 2013. "Really uncertain business cycles," LSE Research Online Documents on Economics 51526, London School of Economics and Political Science, LSE Library.
    3. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
    4. Shigeru Fugita & Garey Ramey, 2006. "Job matching and propagation," Working Papers 06-13, Federal Reserve Bank of Philadelphia.
    5. Tobias Adrian & Nina Boyarchenko, 2012. "Intermediary leverage cycles and financial stability," Staff Reports 567, Federal Reserve Bank of New York.
    6. Nicolas Petrosky-Nadeau, 2014. "Credit, Vacancies and Unemployment Fluctuations," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(2), pages 191-205, April.
    7. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
    8. Saki Bigio, 2012. "Financial Risk Capacity," 2012 Meeting Papers 97, Society for Economic Dynamics.
    9. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
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