Financial Shocks and the Labour Markets: Should Economic Policy Save Jobs?

The recent financial crisis, alongside a dramatic rise in unemployment on both sides of the Atlantic, suggests that financial shocks do translate into the labour markets. In this paper we first present and review the basic facts on unemployment dynamics, financial shocks and Okun's elasticity over the business cycle. Second, we highlight the key mechanisms linking financial shocks to the labour market, drawing on the most recent theoretical and empirical research in the area. Third, and foremost, we discuss whether intervention in the labour market, in the aftermath of adverse financial shocks, should be conducted directly in the labour market (saving jobs) or indirectly through intervention in the financial markets (savings financial institutions). We argue that while there is some evidence that saving jobs can be an effective policy, direct intervention in the labour market should be dealt with particular caution, as the risk of moral hazard and discretionary industrial policy should not be underestimated.