Financial conditions and labor productivity over the business cycle

•The pro-cyclicality of productivity has substantially declined since the mid 1980s.•We provide evidence that financial shocks have impinged on productivity post 1984.•A model with credit frictions and financial shocks is consistent with the evidence.•Binding collateral constraints introduce a wedge in firms demand for labor.•A negative financial shock increases the wedge causing firms to lower labor demand.

The cyclical behavior of productivity has noticeably changed since the mid-80s. We provide VAR evidence that financial shocks have an important effect on productivity. We offer a novel explanation based on the effect of binding collateral constraints on labor demand.