CREDIT CONSTRAINTS AND THE PERSISTENCE OF UNEMPLOYMENT BY: NICOLAS DROMEL, ELIE KOLAKEZ, AND ETIENNE LEHMANN Group C Steven Bodi, Mitchell Steffler, Yaqin Hu, Kelby Krotz, Manmeet Litt, Jordan Kirkpatrick

Outline  General Overview  Literature Review  Model Presentation  Assumptions  Empirical Analysis  Assumptions and regression results  Conclusions  Relevance to public policy

General Overview  The paper argues that credit market imperfections not only impact level of unemployment, it also causes persistence  Entrepreneurs require capital to invest in creating new jobs, which they must borrow from banks – only allowed fraction of pledgeable assets  Too low value of assets = restriction on job creation  Bubbles are assumed away in this model, What if assets are valued too high?  More stringent credit constraints are associated with higher unemployment

 Explanation for this idea: Theoretically: Using a model that extends the steady –state model framework presented by Mortenson and Pissarides (1999) and Pissarides (2000) Empirically: Analysis conducted on 20 OECD countries (1982 – 2003 period) – looking regressions and interaction terms between lagged unemployment and the measure for stringency of credit constraints to explain the persistence.  Underlying premise of research done for this paper draws conclusions for the consequences of credit market frictions More stringency = higher unemployment

Literature  Credit market imperfections credit constraint Kiyotaki and Moore (1997), Aghion (1999), Matsuyama (2007)  Credit market imperfections and business cycle assuming no labour market frictions Bernanke(1989) and Kiyotaki(1997), Aghion (1999) and Matsuyama (2007), Buera and Shin (2008)  Credit market imperfections and unemployment steady-state level of unemployment persistence of unemployment Acemoglu (2001), Redon (2005), Petrosky-Nadeau (2009, 2010)

Matching Model Actors, Framework, and Variables Authors use general equilibrium matching model developed by Morgensen and Pissarides (1999), Pissarides (2000)

Equilibrium Concept DYNAMICS JOB CREATION & CREDIT

Transitional Dynamics of the Economy Under credit constraints the expediency of a return to long-run equilibrium is impeded L t t

ESTIMATED MODELS EMPIRICAL EVIDENCE

Specifications Dependent variable: unemployment (UR_i,t) 14a14b14c14d14e 1-period lagged unemployment (UR_i, t-1) 0.77*** 0.74*** (38.80)(37.36)(32.95)(33.44) Private credit (CRE_i,t) -1.41*** *-0.35 (-3.72)(-0.05)(-1.91)(-1.55) CRE_i,t * UR_i,t ***-0.11*** (-3.27)(-2.74) Replacement rate (ARR_i,t) 0.018**0.12***0.017*0.023***0.041*** (1.97)(6.73)(1.93)(2.62)(3.85) High corporatism (CORP_i,t) -0.69***-2.34***-0.69***-0.77***-0.99*** (-3.14)(-6.13)(-3.12)(-3.44)(-4.23) Union density (UNDENS_i,t) * (1.54)(0.67)(1.51)(0.89)(1.66) Labour tax wedge (TW_i,t) 0.024*0.20***0.024*0.032**0.039*** (1.78)(6.99)(1.66)(2.25)(2.70) Employment protection (EPL_i,t) -0.41***-0.66**-0.40**-0.51***-0.53*** (-2.62)(-1.99)(-2.57)(-3.09)(-3.37) Product market regulation (PMR_i,t) 0.17**0.56***0.17**0.21***0.017** (2.09)(2.94)(2.06)(2.59)(2.10) Output gap (OGAP_i,t) -0.21***-0.44***-0.21*** (-11.97)(-12.9)(-11.83)(-12.37)(-11.75) Observations 369

Main Results

Conclusion & Assumptions  The model assumes all firms face the same constraints in terms of financing.  Entrepreneurs have no capital of their own in this model.  Bubbles are assumed away  At any time: Value of a job = net gain from employee/ (bankers lending costs + job deterioration rate.)  Jobs dissolved exogenously (relation? Credit to replace workers with capital?)  The model and the empirics clearly show that removing credit constraints reduce the equilibrium levels of employment and duration