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Financial Market Imperfections and Labour Market Outcomes

Author

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  • Alireza Sepahsalari

    (University College London (UCL)
    Centre for Macroeconomics (CFM))

Abstract

This paper investigates the importance of credit market frictions on labour market outcomes. I build a tractable search and matching model of the labour market with firm dynamics and heterogeneity in productivity and size. Firms produce output using labour, which they hire in a frictional market modelled by a directed search approach, and capital which they rent period-by-period. First, I show that the interaction of search and financial frictions slows down the reallocation of labour and capital from low productivity to high productivity firms and therefore prolongs the recession following a financial shock. Second, I find that the credit tightening reduces the net employment of large and productive firms more than small and unproductive firms, consistent with recent empirical findings. Third, I find that the introduction of financial frictions enhances the ability of the model to explain the fluctuation and persistence observed in output and labour market flows during the great recession. In fact, the model can account for 50% of the increase in unemployment during the 2008-2010 recession.

Suggested Citation

  • Alireza Sepahsalari, 2016. "Financial Market Imperfections and Labour Market Outcomes," Discussion Papers 1624, Centre for Macroeconomics (CFM).
  • Handle: RePEc:cfm:wpaper:1624
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    File URL: http://www.centreformacroeconomics.ac.uk/Discussion-Papers/2016/CFMDP2016-24-Paper.pdf
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    References listed on IDEAS

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    Cited by:

    1. Yulia Moiseeva, 2020. "The Interaction between Credit and Labor Market Frictions," Discussion Paper Series, School of Economics and Finance 202007, School of Economics and Finance, University of St Andrews.

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    More about this item

    Keywords

    Labour market frictions; Collateral constraints; Financial shocks;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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