Uncovering the mechanism(s): Financial constraints and wages


A large macroeconomic literature has discussed how financial constraints increase the volatility of output and unemployment. This paper documents how (combinations of) existing mechanisms imply very different effects of financial constraints on wages. When wages are at last partly financed externally, the presence of a financial labor wedge lowers wages when financial constraints increase. But financial frictions may also change the relative cost of new hires to employed workers and, hence, interact with labor market tightness such that they increase wages. We test these model implications based on a large data set for Germany for 2006 to 2014 that combines administrative data on workers and wages with detailed information on the balance sheets of firms. We find that both mechanisms are present in the data, with offsetting effects on wages. Overall, higher financial constraints lead to real wage cuts. The two mechanisms therefore affect the uctuations and comovement of tightness and wages over the business cycle in very different ways