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THE EFFECT OF LABOR AND FINANCIAL FRICTIONS ON AGGREGATE FLUCTUATIONS

Published online by Cambridge University Press:  29 December 2014

Haroon Mumtaz  and
Francesco Zanetti
Haroon Mumtaz
Affiliation:
Queen Mary University
Francesco Zanetti*
Affiliation:
University of Oxford
*
Address correspondence to: Francesco Zanetti, Department of Economics, University of Oxford, Manor Road, Oxford OX1 3UQ, UK; e-mail: francesco.zanetti@economics.ox.ac.uk.
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Abstract

This paper embeds labor market search frictions into a New Keynesian model with financial frictions. The econometric estimation establishes that labor market frictions substantially improve the empirical fit of the model. The effect of the interaction between labor and financial frictions on aggregate fluctuations depends on the nature of the shock. For monetary policy, technology, and entrepreneurial wealth shocks, labor market frictions amplify the effect of financial frictions, because robust changes in hiring lead to persistent movements in employment and return on capital that reinforce the original effect of financial frictions. For cost-push, labor supply, marginal efficiency of investment, and preference shocks, labor market frictions dampen the effect of financial frictions by reducing the real cost of repaying existing debt, which lowers the external finance premium.

Keywords

Financial FrictionsSearch and Matching FrictionsNew Keynesian Model
Type
Articles
Information
Macroeconomic Dynamics , Volume 20 , Issue 1 , January 2016 , pp. 313 - 341
Copyright
Copyright © Cambridge University Press 2014 

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