Unemployment Surges in the EU: The Role of Risk Premium Shocks

IMF Working Papers, March 18, 2019

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In the last decade, over half of the EU countries in the euro area or with currencies pegged to the euro were hit by large risk premium shocks.
Risk premium shocks reduce the output level that maximizes profit.
Risk premium shocks lead to unemployment surges as firms cut costs when financing becomes expensive or is no longer available.
All countries with risk premium shocks saw unemployment surge.
Euro area core countries managed to contain unemployment as firms hoarded labor during the downturn.
Wage bills in euro area crisis countries and the Baltics declined even faster than GDP.
In core euro area countries, wage shares actually increased.

The paper shifts focus from demand-side effects (emphasized in previous literature) to supply-side effects of risk premium shocks.
Higher financing costs or loss of financing reduce the profit-maximizing output level, forcing firms to adjust by cutting costs, including labor, which generates unemployment surges.
Divergent labor outcomes across countries reflect differences in firms’ responses: labor hoarding in core euro area countries versus more pronounced reductions in wage bills in crisis countries and the Baltics.

Subjects: Employment, Financial crises, Financial institutions, Labor, National accounts, Return on investment, Sovereign bonds, Unemployment
Keywords: Baltics, debt ratio, Employment, Euro area crisis, financing cost, fincanial crisis, GDP, global economic, interest rate, interest rates, Return on investment, Risk premia, risk premium, risk premium shock, risk premium surge, Sovereign bonds, Unemployment, unemployment surge, WP

IMF Working Paper No. 2019/056 (March 18, 2019).