Collateral crises and unemployment

Eric Tong

New Zealand Economic Papers, 2018, vol. 52, issue 1, 72-90

Abstract: Inspired by the sudden devaluation of ‘safe’ assets at the dawn of crisis, I build a model that features collateralisation in the financial market, and search frictions between employers and workers in the labour market. The model identifies a collateral quality threshold, below which banks switch from unconditional lending to lending contingent on receiving good collateral. The switch explains why a small shock in the collateralised market may lead to sharp losses in job vacancies, such as that seen in the 2008 Great Recession. A trade-off is identified between the proximity and severity of a collateral crisis. Policymakers may manipulate the trade-off, but they cannot eliminate it.

Date: 2018
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DOI: 10.1080/00779954.2016.1230642

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