Financial Factors and Labor Market Fluctuations (Preliminary)

What are the effects of financial market imperfections on the fluctuations in unemployment and vacancies in the labor market? Standard DSGE models are silent about this since they have not modeled unemployment directly. In this paper I augment a standard monetary DSGE model with explicit financial and labor market frictions. The financial frictions are modeled as Bernanke, Gertler and Gilchrist (1999). The labor market frictions are modeled as by a search framework with staggered contracting in nominal wages (Gertler and Trigari (2006)). Assuming the economy is subject to various shocks, including a shock that originates in the financial sector, I estimate the model on the U.S. data. The preliminary results show that the model accounts well for the cyclical behavior of real wage, unemployment and vacancies observed in the U.S. data. The model also accounts well for the cyclical behavior of external finance premium. The simulation results suggest that financial accelerator play an important role in propagating the financial shock. A negative financial wealth shock leads to a rise in unemployment and a decline in vacancy posting. With the financial accelerator mechanism, the financial shock contributes more than 30 percent of the fluctuations in unemployment and vacancies. JEL: classification: E31;E32; E52