Financial Shocks and the Labor Markets: Should Economic Policy Save Jobs?

Reviews the basic facts on unemployment dynamics, financial shocks, and Okun’s elasticity over the business cycle; highlights the key mechanisms linking financial markets and labor markets, drawing on the most recent theoretical and empirical research in the area; and draws attention to the policy implications of this line of research. In the United States, unemployment virtually doubled within a few quarters and is receding only very slowly, while unemployment rates changed much less in Europe, but with considerable heterogeneity across countries. Unemployment has responded much more strongly to the output decline associated with the Great Recession than during earlier contractionary periods. Two channels whereby financial distress can be transmitted to the labor market are the job destruction effect and the labor mobility effect. Policies should focus on saving financial institutions because of their systemic significance, on deciding which sectors to pick for saving jobs, and on arguing for moral hazard, which might predispose firms to build up leverage in anticipation of being helped.