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SAMØKONOMI-Makroøkonomiske utfordringer

Financial Interactions Between Labor Markets and the Macroeconomy

Alternative title: Finansielle interaksjoner mellom arbeidsmarkedet og makroøkonomien.

Awarded: NOK 8.0 mill.

The sharp increase in unemployment in the first quarter of 2020 raised concerns over insolvency and falling asset values. Lessons from the 2008-09 recession put policymakers on high alert - who quickly responded and closely monitored the subsequent response by banks and other creditors on existing and new credit lines. Today, financial and housing markets are at historical highs, and a return to "normal" with higher interest rates may pose a threat to household wealth and businesses' ability to finance new projects. While existing research from the Greaat Recession taught us about the potential effects of high debt levels on the economy, several questions remain unanswered due to a lack of data and empirical strategies to pin down the answers. This project aims to fill some of the remaining literature gaps and help understand how credit markets and labor market policies interact in mitigating the effects of macroeconomic shocks. On one hand, credit lines, originating from home equity, for example, may provide households with credit to buffer the economic consequences of job loss and avoid costly default. On the other hand, credit market frictions and lack of home equity or other pledgeable collateral may prevent a person from accessing credit markets. A key yet unanswered question is whether unemployment insurance (UI) benefits help ease access to credit markets, or public insurance simply crowds out the private insurance from credit markets. By advancing the use of high-quality Norwegian administrative data linking workers and firms to data on income, credit, balance sheets, and collateral, the project studies the interaction between public and private insurance. The project will further advance our understanding of how household debt affects labor markets and whether debt overhang affects outcomes from the job search process. Other questions relating to the role of collateral for small business lending will be addressed, such as whether pledging the business owner's assets provides creditors more information than if the owner pledges the firm's assets? And how does this soft information affect banks' willingness to lend, and firms' ability to hire?

In the first quarter of 2020, businesses worldwide were hit by the outbreak of COVID-19 that brought the economy to a sudden halt. The rapid increase in unemployment gave rise to concerns over whether the effects of rising insolvency rates are reinforced by declining asset values, in particular those of homes, and the subsequent response by banks and other creditors on existing and new credit lines. This project assesses the role of credit markets in reinforcing the impacts of economic shocks like the 2020 shut-down of the economy. Several questions are addressed, such as how collateral constraints lead firms and households to cut back on borrowing and spending, and how fiscal policy can mitigate the propagation of shocks through financial markets into the real economy. Three key features of the Norwegian setting facilitate our studies and allow us to contribute to and bridge several strands of literature in macro, finance, and labor economics. First, access to the universe of business ownership, assets, and pledged collateral allows us to study the role of credit market frictions for small businesses’ access to credit and their hiring decisions. This enables us to provide the first evidence on the role of inside collateral (assets owned by the firm) versus inside collateral (owned by the entrepreneur) and to assess how collateral constraints affect credit and labor markets differentially by aggregate market conditions. Second, comprehensive data on household balance sheets linked to data on job search allows us to study how leverage affects labor supply and job search behavior. This furthers new evidence on how household leverage affects wages, unemployment spells, and labor force participation. Third, the combination of granular micro-data and a unique policy discontinuity that determines the eligibility for unemployment benefit extensions opens up for the first evidence on whether public insurance substitute with or reinforce the effects of credit markets.

Funding scheme:

SAMØKONOMI-Makroøkonomiske utfordringer