Financial frictions, the housing market, and unemployment

By William Branch, Nicolas Petrosky-Nadeau and Guillaume Rocheteau

http://d.repec.org/n?u=RePEc:fip:fedfwp:2014-26&r=dge

We develop a two-sector search-matching model of the labor market with imperfect mobility of workers, augmented to incorporate a housing market and a frictional goods market. Homeowners use home equity as collateral to finance idiosyncratic consumption opportunities. A financial innovation that raises the acceptability of homes as collateral raises house prices and reduces unemployment. It also triggers a reallocation of workers, with the direction of the change depending on firms’ market power in the goods market. A calibrated version of the model under adaptive learning can account for house prices, sectoral labor flows, and unemployment rate changes over 1996-2010.

A great paper that captures some of the essential frictions in the macroeconomy. A great next step would be to bring in some geography. A major friction, I believe, is that when a recession hits a region, the unemployed cannot move to greener pastures because their house cannot be sold. This cannot be captured in the model above because everyone lives in the same economy. The improved model would also be great to capture the cost of this moving friction, which should be taken into account when thinking about homeownership subsidies.

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