What Explains High Unemployment? The Deleveraging – Aggregate Demand Hypothesis

A negative aggregate demand shock driven by household deleveraging is responsible for a large fraction of the decline in U.S. employment from 2007 to 2009. The deleveraging – aggregate demand hypothesis predicts that employment losses in the non-tradable sector will be higher in high leverage U.S. counties that experienced the bulk of the deleveraging process, while losses in the tradable sector will be distributed uniformly across all counties. We find exactly this pattern from 2007 to 2009. Alternative hypotheses for job losses based on uncertainty shocks or structural unemployment related to construction do not explain our results. Using the relation between non-tradable sector job losses and household leverage and assuming Cobb-Douglas preferences over tradable and non-tradable goods, we quantify the effect of deleveraging on total employment. Our estimates suggest that the decline in aggregate demand driven by deleveraging accounts for 4 million of the lost jobs from 2007 to 2009, or 65% of the lost jobs in our data. *We thank seminar participants at New York University (Stern) and Columbia Business School for comments. Lucy Hu, Ernest Liu, and Calvin Zhang provided superb research assistance. We are grateful to the National Science Foundation, the Initiative on Global Markets at the University of Chicago Booth School of Business and the Center for Research in Security Prices for funding. The results or views expressed in this study are those of the authors and do not reflect those of the providers of the data used in this analysis. Mian: (510) 643 1425, [email protected]; Sufi: (773) 702 6148, [email protected]