Anatomy of a Credit Crunch: from Capital to Labor Markets

Anatomy of a Credit Crunch: from Capital to Labor Markets Francisco Buera 1 Roberto Fattal Jaef 2 Yongseok Shin 3 1 Federal Reserve Bank of Chicago and UCLA 2 World Bank 3 Wash U St. Louis & St. Louis Fed December 6th, 213 Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 1 / 22

Background and Questions Understand macro and firm-level implications of credit crunches 1 Why do financial crises lead to severe recessions, and sustained rise in unemployment? Great Depression, 27-28 recession ( Reinhart and Rogoff, 29 ) Propose theory integrating credit and labor market frictions 2 Which type of firms are more strongly affected by credit crunch? Age/size as indicators financial constraints of firms Employment growth in small/young businesses falls relative to old/large Fort, Haltiwanger, Jarmin and Miranda (212) Explore role of age and size in the model uera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 2 / 22

Model Economy Heterogeneous agents in entrepreneurial productivity and wealth run an individual specific technology, work for the wage w t if employment opportunity, search for a job and earn subsidy w t (unemployed). Capital expenditures financed by: internal funds external funds, subject to collateral constraint (Buera and Shin, 29) Labor market friction: Walrasian equilibrium with matching frictions (Veracierto, 29) Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 3 / 22

Main Results Credit crunch = reallocation of factors from constrained to unconstrained entrepreneurs Reduction in TFP (misallocation) Increase in unemployment, as reallocation is mediated by labor friction Reallocation process well captured by firm age and size: small/young businesses: more likely to be constrained, higher return to K net employment growth falls relative to old/large entrepreneurs Aggregate TFP shock has no effect on unemployment (flexible prices) Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 4 / 22

Literature Review Financial frictions and business cycles: Kiyotaki Moore (1997), Bernanke and Gertler (1989) credit frictions and amplification of aggregate shocks Credit shocks and macroeconomic dynamics: Jermann and Quadrini (29) representative agent model, explicitly model debt and equity financing Credit Shocks and Heterogeneous Agents: Khan and Thomas (213), Lorenzoni and Guerrieri (211), Zettlin-Jones and Shourideh (212), Buera and Moll (212) frictionless labor markets Cyclical behavior of firms: Gilrchrist and Gerlter (1994); Chari, Christiano and Kehoe (27); Moscarini Postel-Vinay (212); Fort, Haltiwanger, Jarmin and Miranda (212) Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 5 / 22

Worker (and Unemployed) s Problem v W t (a, z) = max c,a u (c) + βe [ v t+1 ( a, z )] c + a = w t + (1 + r t ) a τ t full insurance against unemployment risk Lump-sum taxes τ t financing unemployment subsidies { } continuation value: v t+1 (a, z ) = max vt+1 W (a, z ), vt+1 E (a, z ) Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 6 / 22

Entrepreneur s Problem v E t (a, z) = max c,k,l,a u (c) + βe [ v t+1 ( a, z )] a + c = A t zk α l θ w t l (r t + δ) k + (1 + r t ) a τ t k λ t a Time series for λ t and A t = non-stationary problem Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 7 / 22

Process of Entrepreneurial Productivity { z z w/ prob. ψ = ξ w/ prob. 1 ψ ξ iid ηξ η 1, ξ 1 Stationary CDF of productivity: µ (z) = 1 z η. Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 8 / 22

Description of Labor Market Friction workers hired in centralized, competitive labor market Friction: only a fraction of unemployed matched to hiring markets Wages adjust to equalize demand and supply in hiring market it takes time for fired, unemployed, agents to match with the centralized hiring market FM matching Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 9 / 22

Mechanics of Labor Market Friction M t unemployed workers matched to the hiring market M t = γ (U t + JD t ) matching evolution of unemployment U t+1 = U t M t + JD t Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 1 / 22

Competitive Equilibrium Given G (a, l 1, z) and a sequence {λ t } t=, a competitive equilibrium consist of sequences of distributions {G t (a, l 1, z)} t=1, allocations, lump-sum taxes, unemployment, and prices {w t, r t } t= such that: Allocations solve individuals problem given prices Government budget is balanced, τ t = w t U t Capital and hiring markets clear ˆ ˆ k t (a,, z) G t (da, dl 1, dz) = ag t (da, dl 1, dz) ˆ Unemployment evolves according to l t (a, z) G (da, dl 1, dz) + U t+1 = L U t+1 = U t M t + JD t The joint distribution G t (a, l 1, z) evolves according to the equilibrium mapping... Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 11 / 22

Calibrating Preference and Technologies US data Model Parameter Top 1 % Employment.69.69 η = 5.25 Top 5% Earnings Share.3.3 α + θ =.79 Establishment Exit Rate.1.1 ψ =.89 Real Interest Rate.4.4 β =.91 Unemployment Rate.5.5 γ =.67 Credit to Non-Financial Assets.7.7 λ = 7.5 Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 12 / 22

Calibrating the Credit Crunch: External Finance / Capital.1.8 data model.6.4.2.2.4.6.8.1 2 22 24 26 28 21 212 214 216 CalibEF uera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 13 / 22

MACRO IMPLICATIONS Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 14 / 22

Aggregate Implications.5 output data.5 TFP model.5.5.1 2 25 21 215.1 2 25 21 215.5 investment rate.12 unemployment.1.8.6.4.2.5 2 25 21 215 2 25 21 215 rigidw workerflows Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 15 / 22

Comparison to an Exogenous TFP Shock.5 output.5 TFP credit TFP.5 2 25 21 215.5 2 25 21 215.5 investment rate.1 unemployment.5.5 2 25 21 215 2 25 21 215 Re-allocative nature of credit shock key for unemployment Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 16 / 22

Comparison to an Exogenous TFP Shock: Prices.1 wage.5 interest rate.4.1.3.2.2.3.4 credit TFP.1.5 2 21.1 2 21 Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 17 / 22

Reallocating External Finance 1 model economy, by wealth U.S. data, by sector and instrument 1.8.8 corporate.6 low a high a.6 corp. bonds.4.4 noncorp..2.2 corp. banks 2 25 21 215 2 25 21 215 Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 18 / 22

MICRO-IMPLICATIONS CREDIT CRUNCH Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 19 / 22

Steady State Properties of Firm Age-Size Distribution Small/large: median employment of employment based distribution Young/old: 5 years since entry (Fort, Haltiwanger, et.al. 212) Table: Statistics from Steady State Age-Size Distribution Fraction Unconstr Entrepreneur Fraction of Total Employment Av. Prod. Av. Wealth Av Rate of Return Net Empl. Growth Rate YS.6.14.59 1.5.15.42 YL.14.5 1.18 3.49.95.28 OS.46.3.57 3.98.46 -.1 OL.96.51 1.17 1.79.42 -.12 Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 2 / 22

Employment Dynamics by Firm Age/Size.15.1.5 Young Small Young Large Old Small Old Large.5.1.15.2.25.3 5 1 15 2 uera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 21 / 22

Conclusions A credit crunch reallocates credit, capital, and labor, i.e., reallocation shock ( TFP shock). Matching frictions reallocation results in protracted rise in unemployment. Age/size of firm good predictor of likelihood of being financially constrained Labor gets reallocated from small/young to large old/businesses Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 22 / 22

BACKUP SLIDES Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 23 / 22

Financial Market Competitive financial intermediaries: issue bonds with return rt accumulate capital K t+1 = (1 δ)k t + I t rent capital at rate rt + δ to entrepreneurs subject to rental limit k λ t a (isomorphic decentralization where entrepreneurs own capital and issue debt) LMdesc Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 24 / 22

Calibrating the Credit Crunch: External Finance / Capital calib model external finance {}}{ ˆ max {k t (a, z) a, } G t (da, dz) (= 1 1/λ t, if all entrepreneurs are constrained) K t data (non-corporate business sector) credit market instruments non-financial assets (historical cost) Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 25 / 22

Frictional Labor Market where M t unemployed workers matched to the hiring market LM LMdesc M t = γu φ t V 1 φ t V t = vjc t (aggregate hiring invesment) evolution of unemployment Veracierto (29) U t+1 = U t M t + JD t Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 26 / 22

Aggregate Implications of Crunch with Rigid Wages (Shimer, 212).5 output.5 TFP.5 data model fixed w.1 2 25 21 215.5.1 2 25 21 215.5 investment rate unemployment.1.5.5 2 25 21 215 2 25 21 215 flexw uera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 27 / 22

Worker Flows: Flexible vs Rigid Wages.6 empl. to non empl. / empl..6 non empl. to empl / empl..5.4.3 data model fixed w.5.4.3.2.2.1.1.1.1.2 2 25 21 215.2 2 25 21 215 flexw Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 28 / 22

Net Employment Growth Rates by Age-Size: The Data Source: Fort, Haltiwanger, Jarmin and Miranda (212) micro Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 29 / 22

Are Age and Size Independently Informative?.5 Net Employment Growth By Size, relative to SS SMALL LARGE Net Employment Growth By Age, relative to SS.1.5 YOUNG OLD.5.1.15.2.25 5 1 15 2.5.1.15.2.25 5 1 15 2 micro Size and Age alone can capture underlying reallocation Size results consistent with Girlchrist and Gertler (1994); Chari, Christiano and Kehoe (27) Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 3 / 22

Implementation Micro-Implications 1 Given SS equilibrium objects: (wealth accumulation decisions, occupation choices, prices) 1 Simulate stationary economy forward. 5, agents 2 Construct empirical age-size distribution 3 Compute Job Creation and Destruction Rates, and other statistics 2 Given Equilibrium objects along crunch, and SS age-size distribution: Buera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 31 / 22

Background and Question Macro and Firm-level Implications of financial crises: 1 Severe contraction, sustained rise in unemployment 2 Employment growth in small/young businesses falls relative to old/large Reinhart and Rogoff, (29), Fort, Haltiwanger, Jarmin and Miranda (212) Propose model with credit and labor market frictions to understand: interaction between credit shocks and labor frictions for macro variables role of firm age and size for transmission of credit shock comparison of implications from TFP shocks uera / Fattal Jaef/Shin (Chicago Fed / World Anatomy Bank/Wash of a Credit U) Crunch: from Capital to Labor Markets December 6th, 213 32 / 22