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Financial Development, Unemployment Volatility, and Sectoral Dynamics

Epstein, Brendan and Finkelstein Shapiro, Alan (2018): Financial Development, Unemployment Volatility, and Sectoral Dynamics.

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Abstract

We document a negative and significant relationship between domestic financial de- velopment and unemployment volatility in developing and emerging economies (DEMEs). However, there is no significant relationship between these variables in advanced economies (AEs). A labor-search model with production heterogeneity, sectoral financial frictions, and interfirm input credit can rationalize these differential cross-country results. Un- employment volatility is decreasing in financial development, but the quantitative relevance of this relationship is increasing in the extent to which input credit is prevalent in an economy. This insight is consistent with the fact that, empirically, input credit is much more prominent in DEMEs compared to AEs.

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