Credit imperfections, labor market frictions and unemployment: a DSGE approach

This paper investigates the impact of credit market imperfections on unemployment, vacancy posting and wages. We develop and simulate a new-Keynesian DSGE model, integrating sticky prices in goods market and frictions in labor and credit markets. A search and matching process in the labor market and a costly state verification framework in the credit market are introduced. Capital spending, vacancies costs and wage bill need to be paid in advance of production and thus require external financing in a frictional credit market. The theoretical model demonstrates how the procyclicality of the risk premium impacts the vacancy posting decisions, the wage and unemployment levels in the economy. Higher credit market frictions are the source of lower posting vacancies and higher unemployment level. Asymmetric information in the signing of a loan pushes up wholesale firms' marginal costs, as well as hiring costs by a financial mark-up charged by financial intermediaries. This financial mark-up is then transmitted by these firms on prices. Thus, it affects their hiring behavior, the wage and employment levels, as well as inflation in the economy. Then, the theoretical model is simulated by using quarterly United-States (US) data for the sample period 1960:Q1 to 2007:Q4. We find that employment rates and vacancy posting increase following positive credit, net worth and uncertainty shocks. Different channels of propagation from the financial sphere of the economy to the labor market are investigated and the results appear to be consistent with our theoretical model.