This paper shows that credit crunches cause labor market effects that are nonlinear over time and heterogeneous by firm age. During the Great Financial Crisis, a credit supply shock caused young firms to reduce employment significantly more than old firms, because the housing bust in 2006 led to a decline in young firms’ housing collateral and restricted their ability to borrow. To understand the underlying mechanism, I propose a financial frictions model with an explicit firm age structure. A simultaneous credit crunch and a decline in young firms’ net worth can reconcile the model with my empirical results. While old firms switch to equity financing, young firms depend on debt financing and cut labor demand. As young firms disproportionately account for aggregate job growth, my findings explain the sluggish labor market recovery after the Great Financial Crisis. A counterfactual experiment shows that absent the net worth shock, the U.S. unemployment rate would have been back to its pre-crisis level two years sooner.
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Brigitte Hochmuth is recent Assistant Professor at the Department of Economics at the University of Vienna and a Fellow at the Institute for Advanced Studies (IHS). Her research interests cover Macroeconomics, especially Macro-Labor, Macro-Finance, and Applied Econometrics. She is working on the macroeconomic effects of credit crunches and labor market policies (such as short-time work and reforms of the unemployment benefit system) in closed and open economies.