Discussion Paper Details

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Title: Financial Risk and Unemployment

Author(s): Zvi Eckstein, Ofer Setty and David Weiss

Publication Date: May 2015

Keyword(s): business cycles, corporate interest rates, equilibrium unemployment, Great Recession, interest rate spread and search and matching models

Programme Area(s): Financial Economics, International Macroeconomics and Labour Economics

Abstract: There is a strong correlation between the corporate interest rate (BAA rated), and its spread relative to Treasuries, and the unemployment rate. We model how interest rates and potential default rates impact equilibrium unemployment in a Diamond-Mortesen-Pissarides model. We calibrate the model using US data without targeting business cycle statistics. Volatility in the corporate interest rate can explain about 80% of the volatility of unemployment, vacancies, and market tightness. Simulating the Great Recession shows the model can account for much of the rise in unemployment. Without Fed action, unemployment would have been 6% higher.

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Bibliographic Reference

Eckstein, Z, Setty, O and Weiss, D. 2015. 'Financial Risk and Unemployment'. London, Centre for Economic Policy Research.