Financial Crises and Labor Market Recoveries: A Bayesian Evaluation

62 Pages Posted: 13 Jan 2021

See all articles by Shahed Khan

Shahed Khan

University of Western Ontario

Date Written: November 3, 2020


Average hours worked in the US recovers much faster than the unemployment rate following financial crises. Using an identified vector autoregression framework with nine quarterly US time series from 1984 to 2014, I find that an adverse financial shock leads to a fall in economic activity with a persistent increase in the unemployment rate but a transitory decrease in average hours worked. I then embed labor market frictions and financial frictions into a New Keynesian model to explain this stylized fact. The model introduces a relatively new financial shock the default cost shock, which captures the financial market’s inefficiency. I estimate the model using Bayesian methods and find that the default cost shock explains a significant portion of the variations in aggregate variables. In particular, this shock accounts for the business cycle features of a financial crisis better than the other relevant shocks do.

Keywords: Financial Crises, Financial Frictions, Search and Matching Frictions, Bayesian Estimation

JEL Classification: E23, E31, E32, E44, E52, G01

Suggested Citation

Khan, Shahed, Financial Crises and Labor Market Recoveries: A Bayesian Evaluation (November 3, 2020). Available at SSRN: or

Shahed Khan (Contact Author)

University of Western Ontario ( email )

Social Science Centre, Room 4071
London, Ontario N6A 5C2

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