Financial frictions, the housing market, and unemployment

• Two-sector search-matching model of the labor market with imperfect worker mobility.
• Incorporate a housing market and a frictional goods market.
• Financial innovations raise acceptability of homes as collateral to finance consumption.
• Effects are to raise house prices, reduce unemployment, reallocate workers across sectors.
• Calibrated version of the model under adaptive learning accounts for key U.S. data.

We develop a two-sector search-matching model of the labor market with imperfect mobility of workers, augmented to incorporate a housing market and a frictional goods market. Homeowners use home equity as collateral to finance idiosyncratic consumption opportunities. A financial innovation that raises the acceptability of homes as collateral raises house prices and reduces unemployment. It also triggers a reallocation of workers, with the direction of the change depending on firms' market power in the goods market. A calibrated version of the model under adaptive learning can account for house prices, sectoral labor flows, and unemployment rate changes over 1996–2010.