Debt Constraints and Employment

RePEc Short ID: pke4
ORCID iD: 0000-0001-5738-1236

Kehoe, Patrick J.; Midrigan, Virgiliu; Pastorino, Elena

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Debt Constraints and Employment

Abstract: During the Great Recession, regions of the United States that experienced the largest declines in household debt also experienced the largest drops in consumption, employment, and wages. Employment declines were larger in the nontradable sector and for firms that were facing the worst credit conditions. Motivated by these findings, we develop a search and matching model with credit frictions that affect both consumers and firms. In the model, tighter debt constraints raise the cost of investing in new job vacancies and thus reduce worker job finding rates and employment. Two key features of our model, on-the-job human capital accumulation and consumer-side credit frictions, are critical to generating sizable drops in employment. On-the-job human capital accumulation makes the flows of benefits from posting vacancies long-lived and so greatly amplifies the sensitivity of such investments to credit frictions. Consumer-side credit frictions further magnify these effects by leading wages to fall only modestly. We show that the model reproduces well the salient cross-regional features of the U.S. data during the Great Recession.

Keywords: Employment; Human capital; Search and matching; Debt constraints;

JEL Classification: E32; J21; E21; E24; J64;