Monday, July 27, 2009

Credit markets and the persistence of unemployment

Some literature has established that the presence of credit constraints can have an impact on the unemployment rate. It can reduce by making it impossible to find credit when unemployed and thus urging unemployed workers to find a job as fast as possible. But it can also increase it, either because structural change in the economy needs investment (and credit) or because search frictions on the labor market are mirrored by search frictions on the credit market. These have been among some explanations offered for why unemployment rate are usually higher in Europe than in America. But his does not explain why the unemployment rate is more persistent in Europe.

Nicolas Dromel, Elie Kolakez and Etienne Lehmann believe credit constraints also have a role to play here. And they do. The key is that during the transition from trough to peek of the business cycle, firms take a while to get financing as their net worth is still low. Net worth is important because it is needed as collateral in this credit constraint world. As credit is slowed, firms cannot hire as fast as they could, and this again hurts their net worth. In the US, credit is available much more broadly than in Europe, and in particular there is more willingness to take a gamble early in the recovery in a recession. This speeds it up and leads to less persistent unemployment. We'll see in the coming months whether this is still true.

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