Aggregate Unemployment and Household Unsecured Debt

Abstract

This paper studies the relationship between the availability of unsecured credit to households and unemployment. We extend the Mortensen-Pissarides model to include a goods market with search and financial frictions. Households, who have limited commitment, face endogenous borrowing constraints when financing random consumption opportunities. We show that borrowing limits depend on the sophistication of the financial system, the frequency of liquidity shocks, and the rate of return on (partially) liquid assets that households can accumulate for self insurance. Moreover, firms' expected revenue is endogenous and depends on firms' market power in the goods market and the availability of unsecured credit to consumers. As a result of the complementarity between credit and labor markets, multiple steady states might exist. Across steady states unemployment and debt limits are negatively correlated. We calibrate the model to the U.S. labor and credit markets and illustrate the effects of an expansion in unsecured debt similar to that seen in the U.S. from 1978 to 2008. Under the baseline calibration, the rise in unsecured credit can account for approximately seventy percent of the decline in the long term average unemployment rate. (Copyright: Elsevier)