Financial Risk and Unemploymentby Eckstein, Setty and Weiss

Joseph ZeiraHebrew University of Jerusalem

Mishkenot Shaananim20/6/2014

A Brief Summary

• The paper studies the effect of financial shocks on unemployment through the model of search in the labor market.

• Financial shocks are modeled as shocks to the borrowers interest rate, which are assumed to be exogenous.

• These shocks affect output through reduction of profit, through increasing the separation rate σ and through the bankruptcy rate ψ.

• The paper simulates these effects in a calibrated model.

Endogenizing the Default Rate I

• The default rate affects on the spread between the lending and borrowing rates.

• But it also depends on the borrowing rate. Profits are negative when:

• Hence, if productivity p is stochastic across firms (but average fixed) this condition determines the probability of default:

•

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Endogenizing the Default Rate II

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Imperfect Capital Markets

• The paper mentions additional elements in the spread, but assumes that they are a fixed proportion of the risk.

• This reduces the ability to assign importance to such factors.

• These were studied extensively in the literature on imperfect capital markets and business cycles.

• Adding a cost of financial intermediation, that is independent, could have an independent and exogenous effect on the spread and makes the model more fit to describe the effects a a financial crisis and of a credit crunch.