Aggregate Implications of Financial Frictions for Unemployment

The Great Recession has witnessed not only a marked disruption in the credit markets and a sharp increase of capital underutilization, but also a severe deterioration of the matching efficiency in the labor market, as evidenced by the historically high unemployment rate and a significant outward shift of the Beveridge curve. Motivated by these facts, I develop a tractable dynamic general equilibrium model to show that financial frictions can manifest themselves as changes in the endogenous matching efficiency in the labor markets. Furthermore, I come up with sufficient statistics to capture the selection and congestion effects of financial frictions on unemployment. The analytical characterization shows that the competing effects crucially depend on interaction between credit imperfections and labor supply elasticity. I then use a calibrated version of the model to show quantitatively that the credit crunch during the financial crisis was a key driving force behind the outward shift of the Beveridge curve, which can explain up to 40% of the rise in the unemployment rate over the business cycles. (Copyright: Elsevier)