Credit Constraints and the Persistence of Unemployment

By Nicolas Dromel, Elie Kolakez and Etienne Lehmann

In this paper, we argue that credit market imperfections impact not only the level of unemployment, but also its persistence. For this purpose, we first develop a theoretical model based on the equilibrium matching framework of Mortensen and Pissarides (1999) and Pissarides (2000) where we introduce credit constraints. We show these credit constraints not only increase steady-state unemployment, but also slow down the transitional dynamics. We then provide an empirical illustration based on a country panel dataset of 20 OECD countries. Our results suggest that credit market imperfections significantly increase the persistence of unemployment.

This paper combines (imperfect) credit markets and labor market frictions. The innovation is that entrepreneurs need to borrow to create jobs, but can do so only up to a fraction of pledgeable assets. The consequences that unemployment level and persistence are dependent on the sophistication of credit markets. While this is empirically consistent, is this a credible model of entrepreneurship and job creation?

One Response to Credit Constraints and the Persistence of Unemployment

  1. M.H. says:

    I am surprised to see the Mortensen-Pissarides still used so much. While is was clearly a great advance in modeling matching frictions when it was introduced, the controversy that erupted with Shimer’s 2005 AER article should have highlighted its major flaws. Also, for a literature that emphasizes so much microfoundations, the reliance on such a black-box reduced form is puzzling.

    Nowadays, we have powerful computers. Why not model the matching process more realistically?

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