The Effect of Collateral Shocks in the Context of Labor Market Frictions

The recent financial crisis was associated with a large and prolonged deterioration to the collateral value and to the collateral-based credit supply. I calibrate a model to explore the impact of collateral shocks on real firm behavior. I discover that: (i) a negative shock to the collateral value depresses the business activities by tightening the borrowing capacity. Such adverse impact is alleviated (worsened) by a lower (higher) productivity-driven credit demand; (ii) following a negative collateral shock, the reduction of labor adjustment costs causes the firms to decrease their activities to a less extent, and such positive effects of labor adjustment flexibility are more pronounced for firms facing a high level of productivity (demand). Empirically, I find that a lower labor unionization rate can mitigate the negative impact of supply shocks on the high-demand firms during the crisis.