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. The model can account for 50% of the increase in unemployment during the 2008-2010 recession.
How do Assets Affect Worker Productivity? (with Jan Eeckhout)
We propose a theory that analyzes how a worker's asset holdings affect her job productivity. In a labor market with uninsurable unemployment risk, the worker's asset holdings affect her job finding probability as well as the productivity of the jobs she applies for. In the absence of insurance, workers with low asset holdings have a precautionary job search motive, they direct their search to low productivity jobs because they offer a low risk at the cost of a low wage. We show that sorting of low asset workers into low productivity jobs occurs under a condition closely related to Decreasing Relative Risk Aversion. We calibrate the infinite horizon economy and find that endogenously choosing the job finding probabilities is quantitatively important. We evaluate a tax financed unemployment insurance (UI) scheme and how it affects welfare. We find that for low asset holders the insurance effect of a rise in UI dominates the incentive effect to search, while the opposite is true for high asset holders. Finally, we compare a one-off severance payment with per period benefits and find that per period benefits generate superior welfare.
Self-Employment in the UK (with Fabien Postel-Vinay)
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