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This paper develops a continuous-time model of the public and private provision of liquidity and its relation to unemployment. We extend the Mortensen-Pissarides model of the labor market by adding an over-the-counter (OTC) market where trades are collateralized with claims on …rms' pro…ts and public liabilities backed by taxes. As a result, the real interest rate is endogenous and depends on the …nancing needs of …rms, the liquidity needs of OTC-traders, and the public supply of liquidity. When the unemployment is ine¢ ciently high, it is optimal to keep liquidity scarce-thereby reducing the total surplus of OTC-traders-to lower interest rates and promote job creation. In a version of the model with …at money and nominal bonds, we show that an increase in in ‡ation reduces the real interest rate and the unemployment rate. We study the dynamics of the labor market under scarce liquidity and we introduce heterogeneity across private claims in order to illustrate how a shock to liquidity demand can generate collateral expansion and increase job creation.JEL Classi…cation: D82, D83, E40, E50 tion opportunities or …rms …nance investment opportunities with collateralized loans or means of payment.Two types of assets can serve as collateral in the OTC market: claims on the pro…ts generated by …rms, and public assets that are backed by the ability of the policymaker to raise taxes. 4 When the supply of liquidity is abundant the interest rate is maximum and equal to the rate of time preference and the total surplus in the OTC market is maximized. When the supply of liquidity is scarce-so that OTC-traders'borrowing constraints are binding-the interest rate falls below the rate of time preference. Firms respond to the lower interest rate by opening more jobs so that total market capitalization increases, which raises the private supply of liquidity in accordance with a Tobin (1965) e¤ect.Our model has a rich set of comparative statics. For instance, regulations that raise collateral requirement for OTC transactions (IMF, 2012, p.95) lead to a reduction in the interest rate, more job creation, and lower unemployment. 5 Moreover, if private assets are heterogeneous in terms of their pledgeability, such regulatory changes lead to collateral expansion, i.e., assets of lower quality that are subject to lower loan-to-value ratios start being used as collateral.As another example, a shock that makes …rms more productive has the standard e¤ect of raising job creation and reducing unemployment, but this e¤ect is dampened by the increase in the interest rate associated with a more abundant private supply of liquidity. Moreover, along the transition market tightness-the ratio of the number of vacancies to the number of unemployed-overshoots its new steady-state value. Indeed, forward-looking …rms anticipate that interest rates will increase over time as the private supply of liquidity increases, and therefore they …nd it optimal to front-load job openings to take advantage of a temporary low cost of funds.An increase in the public su...

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Changes in the costs of trading inputs or final goods affect establishment-level job flows. Using a longitudinal database containing the universe of manufacturing establishments in California from 1992 to 2004, we find that a decline in input or final-good trade costs is associated with job destruction in the least productive establishments, job creation in the most productive establishments, and an increase in the death likelihood of the least productive establishments. The evidence is consistent with predictions of models of trade with heterogeneous firms. Additionally, the evidence shows that the effects of input trade costs on establishment-level job flows are larger than the effects of final-good trade costs.JEL Classification: F14, F16

We thank Penny Goldberg (our discussant), Gordon Hanson, Steve Redding, Peter Schott, and participants at the NBER Trade and Labor Markets Conference for comments and suggestions that improved this paper. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.