Debt Constraints and Unemployment

Virgiliu Midrigan, Elena Pastorino and Patrick Kehoe

No 1118, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: In the Great Contraction, regions of the United States that experienced the largest change in household debt to income ratios also experienced the largest drops in output and employment. Such output drops not only occurred for firms that sell primarily to a local region but also for regional establishments of nation-wide firms that sell highly traded goods to both the rest of the United States and abroad. These patterns are difficult to reconcile with standard models of financial frictions in which tightened financial constraints mainly affect firms' ability to borrow. We develop a Bewley-Huggett-Aiyagari incomplete market model with search and matching frictions of the Diamond-Mortenson-Pissarides type that generates such patterns. Critically, we allow for human capital acquisition by employed individuals, which generates realistic wage-tenure profiles. We show that with such upward sloping wage profiles, an unanticipated tightening of borrowing constraints leads consumers to value less the prospect of consumption when employed and, thus, to find employment relatively less attractive. In equilibrium, firms anticipate this behavior by consumers and consequently reduce the number of vacancies they post. The key result is that in equilibrium the tightening of borrowing constraints generates a path of increased unemployment that lingers, as consumers slowly adjust their asset positions given the tighter constraints, and seemingly `sticky' wages, despite wages being continually renegotiated.

Date: 2014
New Economics Papers: this item is included in nep-dge
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Citations: View citations in EconPapers (8)

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Related works:
Working Paper: Debt Constraints and Employment (2016)
Working Paper: Debt Constraints and Employment (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:1118

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