Unemployment, Financial Frictions, and the Housing Market

We develop and calibrate a two-sector, search-matching model of the labor market augmented to incorporate a housing market and a frictional goods market. The labor market is divided into a construction sector and a non-housing sector, and there is perfect mobility of unemployed workers across sectors. In the frictional goods market households, who lack commitment, …nance random consumption opportunities with home equity loans. The model can generate multiple steady-state equilibria across which housing prices are negatively correlated with unemployment. Relaxing lending standards typically reduces unemployment, but it can have non-monotonic e¤ects on housing prices and supply. It also leads to a reallocation of workers across sectors, the direction of which depends on …rms’market power in the goods market. Quantitatively, we …nd that innovations that generate an increase in home equity-based borrowing of the same magnitude as the one observed during the 90’s explain a reduction in the steady-state unemployment rate between 1/2 and 1 percentage point depending on the calibration strategy. JEL Classi…cation: D82, D83, E40, E50 Keywords: credit, unemployment, housing, limited commitment, liquidity. This paper has bene…tted from useful discussions with Aleksander Berentsen and Murat Tasci. We also thank for their comments seminar participants at the Bank of Canada, at the universities of Basel, Bern, California at Irvine, and Hawaii at Manoa.