Anatomy of a Credit Crunch: From Capital to Labor Markets

Abstract

Why are financial crises associated with a sustained rise in unemployment? We develop a tractable model with frictions in both credit and labor markets to study the aggregate and micro-level implications of a credit crunch--i.e., a tightening of collateral constraints. When we simulate a credit crunch calibrated to match the observed decline in the ratio of debt to non-financial assets of the United States business sector following the 2007-8 crisis, our model generates a sharp decline in output--explained by a drop in aggregate total factor productivity and investment--and a protracted increase in unemployment. We then explore the micro-level impact by tracking the employment dynamics for firms of different sizes and ages. The credit crunch causes a much larger reduction in the net employment growth rate of small, young establishments relative to that of large, old producers, consistent with the recent empirical findings in the literature.

Firm Entry and Financial Shocks

“… Our model is also distinct from work in the macro‐finance literature studying the effect of financial shocks on the allocation of resources between different groups of agents (Bassetto et al ., ; Buera et al ., ), as these papers do not focus on firm entry dynamics and hence do not uncover our finding that a fall in firm entry helps offset the effects of a financial shock on surviving firms. They also do not model the endogenous firm financing decision between debt and equity that drives our results. …”

“…This results from a fundamental implication of the free entry condition, that the impact of a negative financial shock is split between a fall in firm value (and hence firm equity price) and a fall in the number of firms. To the degree that an adverse financial shock lowers the number 4 Our model is also distinct from work in the macro-finance literature studying the effect of financial shocks on the allocation of resources between different groups of agents (Bassetto et al, 2015;Buera et al, 2015), as these papers do not focus on firm entry dynamics and hence do not uncover our finding that a fall in firm entry helps offset the effects of a financial shock on surviving firms. They also do not model the endogenous firm financing decision between debt and equity that drives our results.…”

Liquidity Traps and Monetary Policy: Managing a Credit Crunch

“…For preferences and the demographic structure we set the relative importance of the cash good υ = 0.5, the discount factor β = 0.986 to match a quarterly interest rate of 0.005. We choose the survival rate (1 − γ) = 0.9 1/4 to imply a 10% yearly exit rate of entrepreneurs and set the leverage parameter θ = 0.75 which is consistent with data on credit to real assets in Buera et al (2014). The distribution of productivity z is assumed to be lognormal(0, 1).…”

Who Quits Next? Firm Growth in Growing Economies

“…However, one of the mechanisms that may induce disparities in growth rates across economies is their position in the development spectrum, that is, transition dynamics. Aggregate growth rates and firm dynamics may also vary in response to large economic shocks such as trade reforms (Eslava et al 2004), financial crises (Buera, Fattal-Jaef, and Shin 2015), etc. To address these issues while maintaining the model tractability, we run robustness exercises in which we compute residual variation in growth rates across countries after controlling for income, volatility in growth rates, and time trends.…”