Indebtedness and Unemployment: A Durable Relationship

Abstract

Within a simple formal model, we show that there is a link between workers' consumption patterns and their preferred real wage. A large budget share of illiquid durable consumption goods (such as houses and cars) makes workers more willing to accept a low wage in order to reduce the probability of unemployment, but less willing to lower the real wage if labor demand unexpectedly falls. Moreover, as long as durable consumption goods are financed through imperfectly indexed credit, the budget share of illiquid durable goods affects the impact of inflation on the real wage. These predictions are confronted with data from sixteen OECD countries. We find that high household indebtedness lowers the natural rate of unemployment and increases real and nominal wage rigidity.JEL classification: E24, J51, J64.

Displacement and debt – the role of debt in returning to work after displacement

“…For instance, Barba and Pivetti (2009) find that the burden of servicing household debt pushes workers to work harder. Analyzing French credit markets, Trumbull (2014) synthesizes that “bearing up under the accumulation of debts, and the claim on future income that this implied, workers seemed to become more hesitant to risk losing their jobs and thus less willing to strike.” Furthermore, Ellingsen and Holde (1998) show that indebtedness makes individuals more likely to accept lower wages to keep their jobs as debt makes the unemployment experience more unpleasant. In this regard, debt can be viewed as a burden (or even negative income) and likely enters into the utility function such that work is necessary to repay debt and is thus preferred over leisure.…”

Consumption Commitments and Employment Contracts

“…Ellingsen and Holden (1998) argue that workers who purchase durable goods in expectation of high future wages will make larger purchases and then resist lower wages more than they would had their expectations been pessimistic (and hence durable purchases smaller). Ellingsen and Holden (2002) analyse a model in which worker indebtedness worsens their bargaining position vis‐à‐vis employers.…”