Labour and finance in the aftermath of the Great Recession

Tito Boeri, Pietro Garibaldi, Espen Moen

19 March 2015



New evidence on credit-employment relationship

The 2008 Global Crisis and the associated increase in unemployment on both sides of the Atlantic sparked a new interest in the relationship between financial imperfections and labour market dynamics. In the aftermath of the Crisis, a growing empirical literature has studied the links between financial conditions and employment adjustment. The Great Recession has indicated that firms' leverage and firms' access to finance are clearly correlated to hiring and firing decisions. It is now empirically accepted that frictions in bank lending are correlated to employment losses when credit conditions deteriorate (see micro evidence reported by Chodorow-Reich and Bentolila et al. 2014).1 Our recent research (Boeri et al. 2014) confirms these findings.

Limited pledgeability in the main labour paradigm

The Diamond-Mortensen-Pissarides (DMP) model is the main paradigm for addressing imperfect labour markets. In the baseline framework, there is no role for finance. All projects that display positive net present values are realised and financial markets are assumed to be perfect. What if financial markets are not perfect? Does a different access to finance influence the firm hiring and firing decisions? These basic questions call for a deeper understanding of the relationship between labour and finance. Our research (Boeri et al. 2014) exploits the concept of limited pledgeability proposed by Holmstrom and Tirole (2011). The idea is that only part of the entrepreneur's income is pledgeable and can be borrowed upon, either because part of the income is private benefit or because the entrepreneur needs incentives. By adding financial imperfections and borrowing constraints into an otherwise standard equilibrium unemployment model, our research contributes to the building of an archetype and flexible model of labour and finance.

In our new theory, firms are financially constrained by limited pledgeability and invest in physical capital within an imperfect labour market. Entering firms attract workers by posting vacancies with wages attached to them and hire up to an endogenously determined size that depends on the firms' access to finance. Firms anticipate the possibility that new funding will be needed over the lifetime, and that refinancing may not be available in those times. If that happens, the firm must rely on internal funds for financing the rebuilding of its physical capital. In the absence of such funds, the firm is forced to fire workers and close down its operations.

Merging of two giants

When workers are fired, the firm loses its search capital, defined as the cost of attracting and hiring workers. Ex ante, firms therefore face a trade-off between investing their limited funds in a war chest of liquid funds to protect their search capital, or to invest in more capacity (more employees). Our theoretical model shows that if labour market frictions disappear, so does the motive for firms to hold cash. This implies a fundamental complementarity between labour market frictions and holding of liquid assets by firms that is novel in the literature. In this sense, our work brings together the work on liquidity by Holmstrom and Tirole (2011) with the traditional Mortensen-Pissarides (1994) model of equilibrium unemployment.

New results

Our theoretical work delivers different results.

  • First, our theory uncovers a key complementarity between firms holding cash and labour market imperfections.

In our model, the corporate sector holds cash as a way to protect its search capital, defined as the total hiring cost associated with labour market imperfections. The model predicts also that firms do not hold cash when labour market frictions disappear. While we are aware that the precautionary motives for firms holding cash are many, the complementarity between liquid assets and labour market imperfections is novel and should be investigated in future empirical work.

  • Second, our theory predicts that those firms that hold more cash should be more protected to adverse shock hitting their lender.

The recent empirical evidence suggest that more leveraged firms dismissed more workers during the Great Recession.

  • Third, our research predicts that firms embedded into better functioning financial sectors should be on average more leveraged and less inclined to hold cash.

In addition, the theory predicts that a more financially integrated system should dismiss more labour under adverse financial conditions. We believe that the dynamics of US labour market in early 2007, when compared to the European experience in the aftermath of the financial shock, is revealing in this respect. The US corporate sector is arguably more financially integrated than the European one. When the financial shocks hit in 2007, the US unemployment rose quickly from 5 to 9%, while European unemployment rose only modestly. It is certainly true that labour market institutions in Europe reduced labour shedding, but the dramatic rise in US unemployment is likely to have been the counter part of its finance orientation. The evidence in Boeri et al. (2013) is coherent with this interpretation.


Bentolila, S, J Marcel, J Gabriel and S Ruano (2014), “When Credit Dries Up: Job Losses in Great Recession”, manuscript, CEMFI.

Boeri, T, P Garibaldi and E Moen (2014), “Financial Frictions in Search Equilibrium”, CEPR Discussion Paper 10175, September.

Boeri, T, P Garibaldi, and E R Moen (2013), “Labor and Finance: Facts and Theories”, IMF Economic Review.

Chodorow-Reich, G (2014), “The Employment effects of credit market disruptions: firm-level evidence from the 2008-9 financial crisis”, The Quarterly Journal of Economics, Vol. 125 Issue 1, 1-52.

Holmstrom, B and J Tirole, (2011), Inside and Outside Liquidity, Cambridge: MIT Press.

Mortensen, D, and C Pissarides (1994), “Job Creation and Job Destruction in the Theory of Unemployment”, Review of Economic Studies.


[1]  Chodorow-Reich (2014) and Bentolila et al. (2014) use loan level data for the US and Spain during the 2007/09 financial crisis to identify the effects of banks health on employment changes;



Topics:  Financial markets Global crisis Labour markets

Tags:  credit and employment, global crisis

President, Italian Social Security administration (Inps)

Pietro Garibaldi, a national of Italy, is currently a Professor of Economics at the University of Turin, and director of Collegio Carlo Alberto. CEPR Research Fellow

Professor of Economics, BI Norwegian Business School