House Prices and Job Losses: Gabor Pinter 23rd March 2018

House Prices and Job Losses
Gabor Pinter∗
Accepted Article
23rd March 2018
Abstract
This paper studies the strong comovement between house prices and job losses over
the UK business cycle. An aggregate SVAR and a regional proxy SVAR model are
used to provide empirical evidence on the effect of house prices on labour markets.
To explain the mechanism, a general equilibrium model with collateral constraints,
endogenous job separation and housing shocks is estimated via Bayesian methods. I
find that shocks to housing demand (i) explain about 10-20% of output fluctuations
and 20-30% of labour market fluctuations via the collateral channel, and (ii) were a
major cause in triggering the 1990 and 2008 recessions.
Keywords: UK business cycle, house prices, collateral, unemployment, job separation
rate
∗
First draft: November 2015. Bank of England and Centre for Macroeconomics; email: ga-
bor.pinter@bankofengland.co.uk. This paper contains the views of the author and not necessarily those
of the Bank of England. The author would like to thank, but not implicate Saleem Bahaj, Andy Blake,
Ambrogio Cesa-Bianchi, Clodo Ferreira, Angus Foulis, Peter Gal, Rogrido Guimaraes, Wouter den Haan,
Nobuhiro Kiyotaki, Peter Kondor, Istvan Konya, David Miles, Ben Nelson, Michele Piffer, Morten Ravn,
Ricardo Reis, Christopher Sims, Vincent Sterk, Pawel Zabczyk, Francesco Zanetti, Tao Zha, two anony-
mous referees and seminar participants at the Bank of England for useful comments. Thanks to Felicity
Geary, Emma Lyonette and Ivan Wong for excellent research assistance. Correspondence: email: ga-
bor.pinter@bankofengland.co.uk; address: Bank of England, Threadneedle Street, London, EC2R 8AH,
United Kingdom.
This article has been accepted for publication and undergone full peer review but has not
been through the copyediting, typesetting, pagination and proofreading process, which may
lead to differences between this version and the Version of Record. Please cite this article as
doi: 10.1111/ecoj.12613
This article is protected by copyright. All rights reserved.
The recent macroeconomic literature has shown that the strong comovement between real
estate and labour markets is an important feature of the US business cycle including the
Great Recession (Mian and Sufi, 2014; Liu, Miao, and Zha, 2016). My paper complements
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this evidence by analysing more closely the comovement between labour market flows and
real estate prices over the UK business cycle. A simple illustration of this relationship
is Figure 1, showing that the cyclical components of real house prices and job separation
rates have a correlation coefficient of -0.81 over the sample 1985Q1-2015Q1. This newly
documented stylised fact motivates the two contributions of the present paper.
Figure 1: HP-filtered UK House Prices and Job Separation Rates
House Prices
Job Separation Rate 0.2
0.15
0.15
0.1 0.1
0.05
0.05
0
%
%
0 −0.05
−0.1
−0.05
−0.15
−0.2
−0.1 correlation = −0.81
−0.25
1985 1990 1995 2000 2005 2010 2015
Note: The house price index is from Nationwide and is deflated by CPI; data on separation rates are from Petrongolo and
Pissarides (2008), which uses claimant count flows and excludes job-to-job transitions – see Section C.1 of the Appendix for
further details on data construction. The updated data runs from 1985Q1 to 2015Q1. The logarithm of both series are
HP-filtered with smoothing parameter λ = 1600.
The first contribution is to provide empirical evidence pertaining to the dynamic effects
of house prices on key labour market flow variables. First, I use an aggregate recursive
SVAR model and document that the conditional comovement between house prices and job
separation rates is as strong as the comovement between house prices and job finding rates.
I also find that house price shocks have large and persistence effects on corporate debt which
motivates the placing of the collateral channel in the centre of the theoretical model.
As an alternative model, I propose a regional proxy SVAR model to identify the average
effect of a housing demand shock on the labour markets of the 45 pre-1996 English counties.
The purpose of this empirical model is to use a stronger identification scheme compared to a

recursive SVAR, thereby providing additional robustness checks on the effects of house prices.
As explained further below, this empirical model adopts the proxy SVAR methodology
(Stock and Watson, 2012; Mertens and Ravn, 2013) to a regional context, whereby the
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interaction of aggregate monetary policy shocks and region-specific constraints on housing
supply is used as proxies for regional housing demand shocks. The results corroborate that
housing shocks have a significant effect on labour markets, with the persistence profile of
impulse responses similar to that implied by the aggregate recursive SVAR model.
The second contribution of this paper is to extend theoretical models (Blanchard and
Gali, 2010; Liu, Miao, and Zha, 2016) that assume constant separation rates and focus on
fluctuations in job finding rates in order to explain unemployment dynamics. Accordingly, I
estimate a structural model whereby shocks that increase house prices, also raise the market
value of collateralisable assets that firms own, thereby increasing their borrowing capacity,
leading to an expansion of corporate credit, investment and a reduction in job separation
rates. Regarding the aggregate implications for the UK business cycle, the model implies
that housing demand shocks (unanticipated movements in house prices, not caused by inno-
vations in technology or labour markets) (i) explain about 10-20% of output fluctuations and
about 20-30% of fluctuations in unemployment and job separation rates via the collateral
channel over the forecast horizon, and (ii) were a major cause in triggering the 1990 and
2008 recessions in the UK.
My paper relates to two strands of literature. First, the empirical part of the paper
builds on recent papers that use extensive micro-data and advanced instrumental variable
techniques to identify the causal effect of real estate prices on household and firm dynamics
via collateral effects. A partial list includes Mian and Sufi (2011, 2014), Chaney, Sraer,
and Thesmar (2012), Bahaj, Foulis, and Pinter (2016) and DeFusco (2017). For the present
paper, Bahaj, Foulis, and Pinter (2016) is the most relevant microeconometric study as it
uses UK firm-level data to show that shocks to real estate collateral has significant effect
on firm employment. While these papers typically use static panel data methods, a related
literature (Iacoviello, 2005; Sterk, 2015; Walentin, 2014; Liu, Miao, and Zha, 2016) uses VAR
methods to study the dynamic effects of housing shocks on macroeconomic dynamics. The
regional proxy SVAR model proposed in this paper builds on both literatures by combining

the dynamic analysis of VAR models with cross-sectional instrumentation techniques. Im-
portantly, I build on the recent proxy SVAR methodology (Stock and Watson, 2012; Mertens
and Ravn, 2013) by incorporating measures of regional housing demand shocks as external
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instruments in the VAR model.
Second, the theoretical part of the paper combines financing frictions with Mortensen
and Pissarides (1994)-type search and matching frictions. A number of related papers have
studied the labour market implications of financial frictions (Monacelli, Quadrini, and Tri-
gari, 2011; Hall, 2011; Veracierto, Fisher, and Davis, 2012; Petrosky-Nadeau, 2014). Closest
to my paper is the study by Liu, Miao, and Zha (2016) that estimates a model with Kiyotaki
and Moore (1997)-type collateral constraints – while assuming exogenous job separation –
and shows that shocks to real estate prices can generate substantial volatility in labour
market variables in the US via the collateral channel. Motivated by the strong cyclical
comovement between house prices and job separation in the UK (Figure 1), I extend their
model by introducing endogenous job separation along the lines of Ramey, den Haan, and
Watson (2000), Walsh (2005), Krause and Lubik (2007), Trigari (2009) and Christiano, Tra-
bandt, and Walentin (2011). This theoretical extension is important for understanding not
only the UK business cycle, but may help better quantify the causes of the Great Recession
in the US as well: the results of Liu, Miao, and Zha (2016) suggest that a shock that reduces
real estate prices by 10% increases the unemployment rate by 0.34% points in the US. Given
that the US unemployment rate increased by about 5% points in 2008-2009, and that US
separation rates spiked rapidly, existing models may substantially underestimate the impact
of housing demand shocks because of not accounting for endogenous job separation.1 2
The structure of the paper is as follows. Section 1 describes the empirical models and
provides evidence on the impact of house price shocks on labour market variables. Section 2
describes the theoretical model and presents the results of the Bayesian estimation. Section
1
Though not in the context of housing shocks, but similar conclusions have been reached, amongst
others, by Barnichon (2012): “...ignoring the job separation margin when modeling unemployment will lead
researchers to underestimate the magnitude and speed of adjustments in unemployment around turning
points” (p. 326).
2
Assuming constant separation rates, as in Blanchard and Gali (2010) and Liu, Miao, and Zha (2016)
amongst others, is partly explained by the evidence for the US where job separation has found by Hall (2005)
and Shimer (2012) to be acyclical. These findings have subsequently been challenged by Solon, Michaels,
and Elsby (2009), Fujita and Ramey (2009) and Hobijn and Sahin (2009).

3 discusses the policy implications and concludes.
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1 The Empirical Model
This section provides evidence from two empirical models pertaining to the dynamic effects
of house prices on labour market variables.
1.1 An Aggregate SVAR Model
As the first empirical model, I use a VAR model at quarterly frequency to quantify the
aggregate effects of house price shocks on output, the unemployment rate, corporate debt,
job finding and separates rates. To construct job finding and job separation rates, I extend
the Petrongolo and Pissarides (2008) dataset which uses administrative data on workers
joining or leaving the unemployment register during a period. The aggregate house price
index for all properties at quarterly frequency are taken from Nationwide. The rest of the
data on aggregate variables including output, consumer price index, corporate credit and
the unemployment rate are from the ONS and Bank of England database. Further details
on the data can be found in Section C of the Appendix. The data covers the period 1985Q1-
2015Q1. Using T observations for each k variable, the VAR(p) model can be represented
as:
p
X
Yt = c + δj Yt−j + ut , (1.1)
j=1
where Yt is a (T − p) × k matrix, c is a (T − p) × 1 matrix of constants, the term δ is a k × k

matrix of coefficients, and ut is a (T − p) × k matrix of reduced form residual with variance-
covariance matrix E [u0t ut ] = Σ. The reduced-form errors are linked to the structural shocks
εt by ut = Bεt . I follow the literature (Iacoviello, 2005; Sterk, 2015; Liu, Miao, and Zha,
2016) in employing recursive ordering to identify a housing shock, B = chol (Σ). I use two
lags in the VAR as suggested by the Schwarz Information Criterion.

1.2 A Regional Proxy SVAR Model
As the second empirical model, I adopt the aggregate proxy SVAR approach (Stock and
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Watson, 2012; Mertens and Ravn, 2013) to a regional context in order to identify the average
effect of a housing demand shock on the 45 pre-1996 English counties. The purpose of this
model is to provide a more rigorous identification scheme than the aggregate VAR which uses
the standard Cholesky ordering. The idea behind the regional proxy SVAR model is that
the time series of the interaction of an aggregate housing demand shifter and county-specific
constraints on housing supply may be used as an instrument for exogenous house price shocks
at the county-level. As an aggregate housing demand shifter, I use the monetary policy shock
series of Cloyne and Hurtgen (2016); as a proxy for housing supply constraints, I use the
average refusal rates of planning applications over the period 1979-2008, as constructed by
Hilber and Vermeulen (2016).
Similar to the intuition behind the IV strategy used in static panels (Mian and Sufi
(2011), Chaney, Sraer, and Thesmar (2012) amongst others), housing demand rises when
monetary policy reduces the aggregate interest rate. If local housing supply is very elastic,
the increased demand will translate mostly into more construction rather than higher prices.
If local housing supply is very inelastic on the other hand, the increased demand will translate
mostly into higher prices rather than more construction. I build on this intuition and use
the interaction of aggregate monetary policy shocks and regional supply constraints to trace
out the dynamic effects of housing shocks on regional labour markets in a VAR model.3
To formalise these ideas, I extend the simple VAR model 1.1 in the spirit of the panel
VAR literature (Beetsma and Giuliodori, 2011; Canova and Ciccarelli, 2013). I re-define the
data matrix after pooling the T observations for each region n and each variable k, so that
the dimension of Yt becomes n (T − p) × k. I use a bivariate VAR model, Yt = [HPt , INt, ],
where HPt is the log of real house prices and INt is the log of inflow into unemployment.4
To identify the structural impact matrix B, let mt be a n (T − p)×1 vector of proxy variable
3
My approach also bears similarities with Bartik (1991)-type instruments that combine region specific
industry weights with aggregate shocks to industry employment to isolate shocks to regional labour demand
from regional labour supply.
4
County-level house prices are from the dataset of Hilber and Vermeulen (2016), and inflow into unem-
ployment as measured as new job seeker’s allowance claimants from ONS/Nomisweb. Because of the lack
of reliable employment stock data, I do not use job separation rates at the county level.

defined as the interaction of monetary policy shocks and regional time-invariant measures
of housing supply constraint. Identification of B is now achieved by satisfying the following
conditions:
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E [mt ε1t ] = Φ
(1.2)
E [mt ε2t ] = 0,
which implies that the proxy variable is correlated with the regional housing demand shock
of interest, Φ > 0, and it is uncorrelated with other regional shocks. I implement the
identification scheme 1.2 as described in Mertens and Ravn (2013), after pooling the data
by removing from the regional time-series both county fixed-effects and time fixed-effects.5
1.3 The Dynamic Effects of House Price Shocks
The results from the two empirical models are summarised in Figure 2. Panel A plots the
impulse responses from the aggregate SVAR model.6 A shock that increases house prices
by 1% leads to an economic expansion over the forecast horizon, with the impact on real
output peaking after about one year. The peak effect on the unemployment rate is around
-0.1% points, whereas the impact on separation rates (-1%) is as strong as on job finding
rates (+1%) in absolute value. Regarding the corporate credit variable, the median peak
impact is about 1% occurring about 10 quarters after the shock. This large and persistent
increase in corporate credit is a key motivation behind introducing credit constraints to the
theoretical model in Section 2.
Overall, the empirical evidence suggests that shocks to house prices lead to a strong
comovement between house prices, output and labour markets in the UK. Similar results
have been presented by Liu, Miao, and Zha (2016) and Liu, Wang, and Zha (2013) for
the US. However. in addition to their findings, my SVAR results provide new evidence on
the strong effects on corporate credit and job separation rates – two key variables that the
5
As such, I assume away dynamic interdependencies and heterogeneity in slope and shock variance
(Canova and Ciccarelli, 2013) as well as spatial spillovers (Anselin, 2010). These extensions would be
interesting avenues for future research.
6
In the baseline model I order house prices as the first variable in the SVAR. The results are similar
when house prices are ordered as the last variable in the SVAR. These results are available upon request.

papers above did not include in the SVAR models.7 In the theoretical model presented in
Section 2, I aim to provide a structural interpretation of these results. Moreover, I will use
the DSGE model to check the validity of the recursive ordering structure of the SVAR: it
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will be shown that the estimated housing shock series implied by the collateral channel of
the theoretical model has in fact a reasonably high correlation with the Cholesky-identified
shock in the VAR.
Panel B of Figure 2 presents the results for the regional proxy SVAR model. To get
a sense of the validity of the instrument, I compute the F-statistic from the first stage
regression and find an F-value of 9.8. This is close to the threshold value of 10 suggested
by Stock, Wright, and Yogo (2002) to rule out a reasonable likelihood of the problem of
weak instruments. The impulse responses show that after a 1% shock to county-level house
prices, inflow into unemployment falls persistently, with the peak effect on the number of
new claimants peaking at -0.4% about 2 years after the shock. Note that the persistence
profile of the effect is similar to that implied by the quarterly SVAR in panel A. As shown
by Figure 8 of Appendix A, the results are similar when adding a measure of income to the
SVAR or when the inflow to unemployment is replaced by the unemployment stock.
7
In the working paper version of the present paper (Pinter, 2015), I provide evidence regarding the effects
of housing shocks on corporate credit and job separation rates in the US. I find sharp and significant effects
on job separation rates and somewhat modest effects on corporate credit.

Figure 2: The Effects of a House Price Shock in the UK
(a) Results from an Aggregate Recursive SVAR Model
House Prices Output

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1.5 0.2
1
%
%
0.5 0
0
−0.5 −0.2
5 10 15 20 5 10 15 20
Unemployment Rate Corporate Debt
0.1 1.5
%−points
%
0
0.5
−0.1 0
5 10 15 20 5 10 15 20
Job Finding Rate Job Separation Rate
1
1
0
%
%
0
−1
−1
5 10 15 20 5 10 15 20
Quarters Quarters
(b) Results from a Regional Proxy SVAR Model

House Prices
1
%
0.5
0
0 1 2 3 4 5
Inflow into Unemployment

0.2
0
%
−0.2
−0.4
0 1 2 3 4 5
Years
Notes: The aggregate SVAR model (panel A) is in levels and includes a constant. The identification is with Cholesky trian-
gularisation with house prices ordered first. The sample period is 1985Q1 - 2015Q1. The regional proxy SVAR model (panel
B) includes two lags and uses annual data for the 45 pre-1996 counties spanning the period 1984 - 2007 (1080 observations
in total). Following Stock and Watson (2012) and Mumtaz, Pinter, and Theodoridis (2017) I assess the first-stage using the
F-statistic=9.8, measuring the strength of the instrument which is the interaction of the narrative measure of UK monetary
policy shocks (constructed by Cloyne and Hurtgen (2016)) and the refusal rates of planning applications averaged over 1979-
2008 (as constructed by Hilber and Vermeulen (2016)). Inflow into unemployment is measured as the log of the average yearly
number of new claimants of job seeker’s allowance. The shaded area depicts the 95% confidence bands.
It is worth noting that the effect the regional proxy SVAR model identifies is ultimately
an average local effect; hence it is not obvious how to map the obtained estimates to inform-
ing the aggregate business cycle model, estimated on aggregate UK data.8 Nevertheless, the
regional proxy SVAR methodology has an important advantage: it relies on a cleaner iden-
tification scheme than the aggregate SVAR model, thereby providing an essential diagnostic
8
Such an exercise would necessitate the explicit modelling of regional heterogeneity in the spirit of the
recent open-economy literature (Nakamura and Steinsson, 2014; Farhi and Werning, 2017; Martin and
Philippon, 2017).

tool for estimating the dynamic effects of housing shocks.9
1.4 Decomposing Unemployment Fluctuations

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Given the strong aggregate relationship between job separation rates and house prices in the
UK (Figure 1), it is natural to ask how much of the aggregate dynamics of the unemployment
rate is explained by fluctuations in job finding and job separation rates. I use the empirical
framework, used by Petrongolo and Pissarides (2008) and Fujita and Ramey (2009) amongst
others, which decomposes quarterly changes in the unemployment rate into changes in the
inflow and outflow rates. A brief summary of the methodology is provided in Section C
of the Appendix. Table 1 shows the results of this decomposition confirming the increased
role of separation rates during UK recessions. Consistent with the findings of Petrongolo
and Pissarides (2008), separation rates are overall important in explaining UK unemploy-
ment dynamics, and their importance increases during periods of increasing unemployment
rates. Relative to their paper, the additional result is that more than half of unemployment
volatility is explained by the inflow rate during and after the Great Recession.
Table 1: Contributions from the Inflow Rate to Unemployment Volatility
Period Feature βs
1985Q1-2006Q4 Pre- Great Recession 0.38
1993Q1-2006Q4 Falling u 0.26
1985Q1-2015Q1 Whole Sample 0.42
2007Q1-2015Q1 Post- Great Recession 0.57
Notes: βs is calculated as the ratio of the covariance between the contribution of the inflow rate and the change in steady-state
unemployment to the variance of the change in steady-state unemployment. The calculation follows Petrongolo and Pissarides
(2008) and Fujita and Ramey (2009).
2 The Theoretical Model
The model is infinite horizon and is in discrete time. The economy features three agents:
households, entrepreneurs and producers. Households work, consume, purchase residential
9
Moreover, the estimated average local effect can be compared to the macroeconomic effect implied
by the aggregate SVAR model. As an example, observe the effect of a 1% shock to house prices on the
unemployment stock (Figures 8–9 in Appendix). The two empirical models yields IRFs that have similar
persistence profiles; though the aggregate SVAR model seems to deliver somewhat larger effects, which may
be due to regional spillovers (that the regional proxy SVAR does not account for), to the equal weighting
applied by the regional proxy SVAR model, or to other general equilibrium effects.

land and save through a one-period riskless discount bond. Entrepreneurs consume, pur-
chase capital and commercial land which they partly finance with debt issuance that is
collateralised by their capital stock and commercial land holdings. Each producer, owned
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by the entrepreneurial sector, rents capital and land from the entrepreneur, and hires one
worker from the household sector to form an employment match.
Each employment match is subject to an idiosyncratic preference shock that hits the
worker. Intuitively, this shock can be thought of as a degree of ‘shirking’, which is different
across individuals. If the realisation of the shock is above a certain threshold level, the
employment relationship is discontinued. This threshold level is lower and job separation
is increased when aggregate credit constraints tighten and economic conditions deteriorate.
Another words, shirking is not what will drive job separation in the model, but it is produc-
ers’ tolerance to shirking that falls when aggregate credit constraints tighten, resulting in
increased firing activity. The main text provides a brief description of the model, whereas
the full exposition of the model is found in Section B of the Appendix.
2.1 Description of the Model
2.1.1 Households
Each household can be thought of as a large extended family with a continuum of employed
and unemployed members. The utility function is written as:
∞
β t At {log (Ch,t − hh Ch,t−1 ) + ϕt log Lh,t − Gt } ,
X
U =E (2.1)
t=0
where Ch,t denotes consumption and hh is the degree of internal habit formation. The
parameter β is the subjective discount factor, At is a preference shock; land holdings of
the household are denoted by Lh,t with the corresponding taste shifter ϕt referred to as a
housing demand shock, whereas Gt denotes the sum of disutilities from labour supply of
the employed household members. Following Trigari (2009), each member has the following
disutility from labour:
h1+ν
g (ht , at ) = χ t
+ 1at , (2.2)
1+ν

where ht denotes labour hours with scale parameter χ and inverse Frisch elasticity ν. More-
over, at is an idiosyncratic shock to the disutility of working which is assumed to be i.i.d.
across individuals and across time with cumulative distribution function of the lognormal
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family F (a) with parameters µa and σa , and density f .10 The indicator function 1 takes
the value one (zero) if the individual is employed (unemployed). The sum of the disutilities
of employed members is equal to the family’s disutility from supplying labour hours, Gt .
The flow-of-funds constraint is:
St
Ch,t + ql,t (Lh,t − Lh,t−1 ) + = Wt ht Nt + St−1 + bZtp (1 − Nt ) − Tt , (2.3)
Rt
where Wt is the real wage, Rt is the gross riskfree return, St is the purchase in period t of the
loanable bond that pays off one unit of consumption good in all states of the world in period
t + 1, which is known in advance. In period 0, the household starts with S−1 > 0 units of
the loanable bonds. Tt refers to lump-sum taxes, and unemployment benefit is denoted by
b which is scaled by Ztp so that it remains stationary relative to labour income.
2.1.2 Entrepreneurs
The entrepreneur’s utility function is written as:
∞
β t {log (Ce,t − he Ce,t−1 )} ,
X
U =E (2.4)
t=0
where Ce,t denotes the entrepreneur’s consumption and he is the habit persistence.11 The
entrepreneur is endowed with K−1 units of initial capital stock and L−1,e units of land.
Capital accumulation follows the law of motion:
10
The assumption of i.i.d. shocks follows the majority of the literature on endogenous separation (Ramey,
den Haan, and Watson, 2000; Walsh, 2005; Krause and Lubik, 2007; Trigari, 2009; Christiano, Trabandt, and
Walentin, 2011), and it implies that today’s separation of the worker does not affect tomorrow’s separation.
While keeping the model tractable the i.i.d assumption leads to persistence in the response of aggregate
separation rates, which is consistent with the previous literature above and with the VAR evidence of the
previous Section (Figure 2). Recently, Cheremukhin (2012) explored adding persistence to the idiosyncratic
taste shock process in a similar search and matching model. His estimation results suggest that such an
extension of the model does not generate material changes compared to his baseline i.i.d. assumption.
11
Note that entrepreneurs in the present model do not consume durables. The model analysed in Bahaj,
Foulis, and Pinter (2016) includes such a feature, which is motivated by their microeconometric evidence
confirming that entrepreneurs (company directors) indeed use residential property as collateral when seeking
external financing for their firms. This is however a different mechanism that is complementary to the present
paper.

 !2 
Ω It
Kt = (1 − δ) Kt−1 + 1 − − λ̄I  It , (2.5)
2 It−1
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where It is investment, λ̄I denotes the steady-state growth rate of investment, and Ω >
0 is the adjustment cost parameter. The entrepreneur faces the following flow-of-funds
constraint:
It Bt
Ce,t + ql,t (Le,t − Le,t−1 ) + + Bt−1 = + Rk,t Kt−1 + Rl,t Le,t−1 + Πt , (2.6)
Qt Rt
where Bt−1 is the amount of matured entrepreneurial debt and Bt /Rt is the value of new
debt. Rl,t and Rk,t are the rental rates of land and capital, respectively, and Πt denotes the
flow of profits. Qt is the investment-specific technological change (Greenwood, Hercowitz,
and Krusell, 1997). The entrepreneur’s ability to obtain credit is subject to the following
collateral constraint (Kiyotaki and Moore, 1997):
Bt ≤ θt Et [ql,t+1 Le,t + qk,t+1 Kt ] , (2.7)
where qk,t+1 is Tobin’s q, and ql,t+1 is the land price. As in Jermann and Quadrini (2012),
the collateral constraint is subject to a stochastic disturbance θt . Equation 2.7 will be key
in propagating the housing shock to labour markets.
2.1.3 Labour markets
At the beginning of time t, there are ut unemployed workers looking for jobs, and there are
vt vacancies posted by producers. The technology of matching workers with vacancies is
written as:
mt = ψt uωt vt1−ω , (2.8)
where ω ∈ (0, 1) is a technology scale parameter, and ψt is an exogenous matching efficiency

shock. The number of workers employed at the beginning of time t is denoted by Nt−1 . Be-
fore matching takes place, workers lose their jobs with probability ρt before matching starts
at time t. Job separation has an exogenous, constant component, ρx , and an endogenous

component, ρnt , total separation is written as ρt = ρx + (1 − ρx ) ρnt . The endogenous compo-
nent ρnt depends on whether the realisation of the idiosyncratic preference shock at (equation
2.2) is above a certain threshold āt , at which the employment relationship is discontinued:
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ρnt = P r (at > āt ) = 1 − F (āt ) . (2.9)
The evolution of employment Nt follows the law of motion Nt = (1 − ρt ) Nt−1 + mt . This

implies that employment at the current period is the sum of the workers that survived from
the last period and the number of matches formed at the beginning of the current period.12
Given the dynamics of employment, the unemployment rate is determined by the identity
Ut = 1 − Nt .
2.1.4 Producers and Nash bargaining
Production is done by firms who rent capital kt and land le,t from the entrepreneur, and use
the labour hours ht of a matched worker. These inputs are combined in a Cobb-Douglas
technology:
α
φ 1−φ
yt = Zt le,t kt h1−α
t , (2.10)
that is subject to stochastic technology shocks Zt . Firms and matched workers bargain over
the wage (Wt ) and working hours (ht ) in a Nash bargaining process:
ξt 1−ξt
max JtW − JtU JtF , (2.11)
Wt ,ht
where JtW denotes the current value of employment, JtU is the current value of unemploy-
ment, JtF is the value of the employment match and ξt is a shock to the worker’s relative
bargaining power shich will be estimated. The solution to problem 2.11 is identical to Liu,
Miao, and Zha (2016) with the important exception of the additional zero joint surplus
condition determining endogenous separation. Details of the Nash bargaining and a full
description of the model can be found in Section B of the Appendix.
12
The assumption regarding the timing of the probability of separation follows Krause and Lubik (2007),
and the timing of newly formed matches is the same as in Blanchard and Gali (2010) and Liu, Miao, and
Zha (2016).

2.1.5 Estimation
The model is log-linearised around the deterministic steady-state in which the credit con-
Accepted Article
straint is binding. The model is used to fit six quarterly UK time series: real house prices,
real per capita investment, real per capita output, real per capita corporate (PNFC) debt,
the unemployment rate and the job separation rate. The data sample covers the period
from 1985Q1 to 2015Q1. The choice of the starting date is motivated by the fact that the
period before 1985 was characterised by large structural changes in the UK labour mar-
kets (Pissarides, 2003). Details about the estimation can be found in Section C.3 of the
Appendix.
2.1.6 The concept of housing shocks
Given that the focus of this paper is the impact of housing shocks (ϕt in the model) on
labour markets, it is instruct to briefly discuss what this object may proxy. While housing
shocks feature prominently in a number of recent papers13 , the literature is yet to provide
a definite answer to this question. According to Iacoviello and Neri (2010), these shocks
“represent genuine shifts in tastes for housing, or could be nothing else but a catchall for all
the unmodelled disturbances that can affect housing demand” (pp. 150). This view is echoed
by Liu, Wang, and Zha (2013) stating that this shock “simply represents an exogenous shift
in the household’s taste for housing services... Another interpretation is that a housing
demand shock...is a reduced-form representation of frictions or some deeper shocks that are
outside of the model” (pp. 1180).
A more structural explanation is that these shocks may capture regulatory changes in
mortgage and credit markets which would affect housing demand and house price behaviour.
While these factors may plausibly explain low-frequency changes in UK house prices (Muell-
bauer and Murphy (1997)), they are less likely to be relevant at business cycle frequency as
shown by Figure 1.14 A perhaps more plausible narrative could be that house price shocks
capture general shifts in optimism about the housing market. There is indeed an increasing
13
See Iacoviello (2005); Iacoviello and Neri (2010); Adam, Kuang, and Marcet (2012); Liu, Wang, and
Zha (2013); Liu, Miao, and Zha (2016); Sterk (2015) amongst many others.
14
Nevertheless, this possibility will be explored by the structural model in Section 2 in the form of
introducing stochastic disturbances in corporate credit constraints following Jermann and Quadrini (2012).

literature on the time-varying nature of housing investor expectations (Piazzesi and Schnei-
der (2009) and Case, Shiller, and Thompson (2012)). This could also be complemented
by the role of foreign demand – a factor particularly relevant to the UK (Badarinza and
Accepted Article
Ramadorai, 2017). In this sense, shifts in housing demand can be driven by shifts in housing
return expectations without any necessary shift in labour income profiles. Moreover, hous-
ing shocks in the aggregate model may capture some of the heterogeneous effects of other
macroeconomic shocks that propagate through house prices.15
While the author is sympathetic to all these interpretations, one can argue that it is
still a meaningful pursuit to quantify the effect of exogenous disturbances in house prices
(and test whether the collateral channel can propagate these disturbances to the rest of the
economy) without providing an exact definition of what these disturbances are. The rest of
this paper will do exactly that.
2.2 The Impact and Importance of Housing Shocks
Given the estimated modes of the parameter values, the impulse responses are calculated
for observables in order to assess the effects of an exogenous shocks to housing demand ϕt ,
as shown in Figure 3. The IRFs are normalised to deliver 1% increase in real house prices.
The black circled lines denote the baseline results. The blue dashed lines denote the case
whereby credit constraints are exogenous, as discussed further below.
The baseline result shows that shocks to house prices generate an economic expansion
with a 0.3% peak impact on output.16 The unemployment rate falls 1.5% below its steady-
state value (8%) that is consistent with the results from the VAR model (Figure 2). The
15
For example, heterogeneity in terms of geographical location (Beraja, Fuster, Hurst, and Vavra, 2017) or
households’ housing tenure (Cloyne, Ferreira, and Surico, 2016) can make house prices an important factor
in propagating monetary policy shocks. Adding these features explicitly to the present model would be an
interesting avenue for future research, especially given the results from the regional proxy SVAR model.
16
Note that the housing shock has a very persistent effect on house prices. This is due to three things:
(i) the household’s land Euler equation, (ii) the observables used in the estimation and (iii) the location of
the housing shock, i.e. the Euler-equation, ql,t = Et Λt,t+1 ql,t+1 + ϕt M RSt , puts strong restriction on two
observables: house prices, ql,t , and consumption (effectively output minus investment) driving the marginal
rate of substitution between consumption and residential land M RSt . Given that ql,t is much more volatile
in the data than the M RSt , the model needs very persistent housing shocks ϕt to satisfy the Euler-equation
(analogous to the volatility paradox (Shiller, 1981) in the finance literature). This could be viewed as a
symptom that linearised, rational expectations models such as my model (and in fact most other estimated
models in the literature such as Iacoviello and Neri (2010); Liu, Wang, and Zha (2013); Liu, Miao, and Zha
(2016)) needs to rely largely on the exogeneity of house prices because the Euler-equation does not deliver
sufficient amount of propagation of other structural shocks (via the M RSt ) to house prices.

Figure 3: The Impact of Housing Shocks in the DSGE models
House Prices Output Investment

1.5
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1
0.2 1
0.5 Endogenous Credit Constraint 0.1 0.5
Exogenous Credit Constraint 0
0 0
0 5 10 0 5 10 0 5 10
Consumption Corporate Credit Wage Bill
1.5
0.05 0.15
0 1 0.1
−0.05 0.5 0.05
−0.1
0 0
0 5 10 0 5 10 0 5 10
Unemployment Rate Job Finding Rate a
0
1
−0.5 0.6
0.5 0.4
−1 0.2
−1.5 0 0
0 5 10 0 5 10 0 5 10
Job Separation Rate Vacancies Labour Market Tightness
0
1.5 2
−0.5 1
−1 0.5 1
−1.5 0
−0.5 0
0 5 10 0 5 10 0 5 10
Quarters Quarters Quarters
Note: The black lines represent the IRFs to a housing shock in the DSGE model using the estimated modes of the
parameters. The blue dashed lines denote the counterfactual with the credit constraint fixed to its steady-state level.
main mechanism is related to the collateral channel: a positive shock to house prices in-
creases the borrowing capacity of the entrepreneur leading to increasing demand for capital
and commercial real estate resulting in an economic expansion. Profits, the value of an
employment match and the current value of vacancies all increase, resulting in increased job
creation and movements along the downward-sloping Beveridge curve.
Moreover, the present model also features endogenous wage rigidity that the housing
shock induces, which is referred to as the “labour channel” of the housing shock (Liu,
Miao, and Zha, 2016). This is because the direct effect of the housing preference shock is
to generate a substitution away from non-durable to durable consumption. In turn, the
collateral channel propagates the shock to generate an overall economic expansion, and the
resulting wealth effect has a positive effect on non-durable consumption. The net effect of a
positive housing shock in the current estimation is to generate small and positive movements
in the marginal utility of non-durable consumption of the household. Therefore, workers’
power during the bilateral wage bargaining process increases by little in spite of the economic
expansion.
Both the collateral and the labour channels have additional consequences in the present

model via the equilibrium condition determining endogenous job separation, which is written
in log-linearised form17 :

ˆt = ω1 Ŷt − N̂t + ω2 Θ̂t + λ̂h,t .
ā (2.12)
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The zero joint surplus condition implies that increases in labour productivity Ŷt − N̂t and
in labour market tightness θ̂t are positively related to the threshold value of the preference
ˆt .18 The labour productivity term in equation 2.12 captures the current joint payoff
shock ā
from continuing the employment relationship, whereas the labour market tightness term
represents the expected future joint payoffs. Housing shocks increase labour productivity
(Liu, Wang, and Zha, 2013) and labour market tightness (Liu, Miao, and Zha, 2016) via
the collateral channel. A key question is related to the dynamics of the marginal utility of
consumption λ̂h,t in response to shocks. To the extent that housing shocks generate little
variation in λ̂h,t , a positive housing shock can thereby generate substantial increases in the
ˆt . This in turn lowers endogenous separation through equation 2.9. It
threshold value ā
thereby triggers an immediate fall in the number of unemployed workers searching for jobs,
hence pushing down on the unemployment rate. According to the DSGE estimation results,
this additional channel via changing the destruction rate of existing employment matches is
at least as important as the channel affecting the value of new employment matches.
Note that the estimation results also imply a strong comovement between house prices
and labour market tightness. To provide an informal test of this implication, I use aggregate
vacancy data from the ONS to construct a time-series of the vacancy-unemployment ratio,
and compare its cyclical properties to that of the aggregate house price index. Figure 10
in Appendix confirms that there is a close relationship between the two time-series over the
1980-2015 period.
To disentangle the collateral channel from the labour channel, I recompute the IRFs
after fixing the collateral constraint to its steady-state value.19 The blue dashed lines in
Figure 3 confirm that the endogenous interaction between real estate prices and corporate
lending is indispensable for generating the comovements between house prices and labour
17
Here we assume no shocks to the bargaining power ξt for expositional purposes.
18
The parameters ω1 and ω2 are functions of the model’s deep parameters and steady-state values: ω1 =
ω−1
λ̃h ν(1−α) Ỹ λ̃h κΘ(ωΘ /ψ̄−ξ )
ā 1+ν N and ω2 = ā 1−ξ . Under realistic parameterisations, it is true that ωΘω−1 /ψ̄ > ξ.
19
I thank an anonymous referee for this suggestion.

market variables. When credit constraints are exogenous, the impact of housing shocks
drops dramatically.
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Table 2: Posterior Variance Decomposition
Pref Housing Collateral Labour Techn Pref Housing Collateral Labour Techn
Output House Prices
4Q 13.55 22.14 29.56 2.09 32.67 5.57 88.92 0.40 0.04 5.08
8Q 16.22 20.69 27.07 4.04 31.97 5.02 86.98 0.78 0.04 7.17
16Q 19.03 18.11 23.92 8.49 30.44 4.47 87.98 1.44 0.07 6.04
24Q 19.37 17.13 22.37 12.23 28.90 3.81 90.07 1.41 0.11 4.60
Investment Corporate Debt
4Q 28.79 25.34 36.13 0.33 9.40 4.15 20.23 56.88 0.02 18.72
8Q 30.39 23.08 34.87 0.93 10.72 4.68 18.47 55.54 0.08 21.23
16Q 28.81 20.46 31.06 1.87 17.80 5.60 16.76 55.74 0.31 21.59
24Q 27.25 20.29 29.88 2.22 20.35 6.04 16.03 56.18 0.59 21.16
Unemployment Rate Job Separation Rate
4Q 22.34 30.81 16.68 25.30 4.88 23.81 29.20 15.23 25.89 5.87
8Q 20.95 25.71 10.64 36.42 6.27 20.55 23.38 11.39 34.17 10.51
16Q 14.92 16.83 8.78 50.03 9.44 15.03 16.98 12.65 41.08 14.26
24Q 11.63 13.22 11.11 54.38 9.67 12.98 14.62 14.28 44.08 14.04
Job Finding Rate Labour Market Tightness
4Q 7.44 12.09 7.04 70.96 2.47 11.12 18.08 10.52 56.58 3.69
8Q 5.58 8.43 4.47 79.73 1.78 8.84 13.36 7.08 67.89 2.83
16Q 3.73 5.44 3.33 86.16 1.34 6.12 8.93 5.47 77.28 2.19
24Q 2.98 4.37 3.14 88.37 1.14 4.91 7.20 5.18 80.83 1.88
Note: For each variable, variance decompositions over different horizons are generated by the DSGE model evaluated at the
mode of the posterior distribution which is constructed after drawing 200,000 MCMC chains. The intertemporal preference,
housing and collateral shocks are treated separately. The labour shock combines the effects of the matching efficiency and
bargaining shocks. The column ’Techn’ combines the effects of permanent and transitory shocks to TFP and investment-specific
technological change.
To further explore the model’s quantitative implications, I use the estimated parameters
to calculate FEV decompositions the observed macroeconomic variables. Table 2 shows
that the housing shock alone explains about 10-20% of output fluctuations, and 20-30%
of investment, credit, unemployment and separation rate fluctuations over the two-year
horizon.
Overall, the two financial shocks (i.e. the housing shock and the collateral shock) explain
more than half of investment fluctuations and about third of output fluctuations in the UK.
These results confirm recent findings of Jermann and Quadrini (2012); Liu, Wang, and
Zha (2013); Christiano, Motto, and Rostagno (2014) regarding the importance of financial
shocks in the US. Technology-type shocks continue to be an important source of business
cycle fluctuations in the UK mainly because of their contribution to consumption volatility.

They do however explain little of labour market fluctuations (Shimer, 2005). These results
are quantitatively similar to recent UK findings presented by Faccini, Millard, and Zanetti
(2013). Labour market shocks, not surprisingly, have large effects on unemployment and
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separation rates, but they propagate little into house prices and investment. However, their
importance for output fluctuations increases with the horizon, which is consistent with the
recent business cycle literature since Smets and Wouters (2007).
Figure 4: Comparing the DSGE and VAR Identified Housing Shocks
BVAR model
DSGE model
3
correlation = 75.9 %
−1
−2
1990 1995 2000 2005 2010 2015
Note: The black solid (blue dashed) line is the housing shock series from the DSGE (VAR) models. The shocks are
normalised by the estimated standard deviations that are 0.025 and 0.045 in the VAR(1) and the DSGE models, respectively.
To take a closer look at the properties of the housing shock, Figure 4 plots the estimated
time-path of the identified shock series in VAR and DSGE models. In terms of the statistical
implications, the two series have a high, 76%, correlation. This suggests that while providing
a structural interpretation of how house prices can affect labour markets via the collateral
channel, the DSGE model comes close to recovering the structural shock series implied by a
reduced-form BVAR model. In terms of the historical implications, Figure 4 suggests that
the early 1990s were characterised by larger shocks to house prices than the recent Great
Recession. To quantify the relevance of house price shocks and the collateral channel, the
next subsection will compute the counter-factual paths of the UK economy that would have
been realised if housing shocks had been absent.

2.3 Causes of the 1990-91 and 2008-09 UK Recessions
The early 1990s were characterised one of the largest collapse of real estate prices in UK post-
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war economic history. Real house prices started falling rapidly in 1989Q2 and by 1995Q4
the accumulated loss in real value amounted to almost 40%. A large fraction of the initial
collapse is interpreted by both the DSGE and the BVAR models as being unrelated to other
structural shocks in the economy, and the collapse was mainly driven by housing shocks as
shown by Figure 4. About a year after the initial shock, in 1990Q2, unemployment started
rising from 6.9%, and continued to increase for eleven consecutive quarters, reaching 10.6%
by 1993Q1.
Figure 5 shows the counter factual paths (blue dash lines) along the actual macroeco-
nomic outcome (black solid lines). In the counter-factual economy, house price growth would
have been stable, and the fall in output would have been muted mainly because corporate
credit growth would have remained positive all the way till 1991Q1, supporting business
investment and to a smaller degree consumption. The implications for labour markets are
vast: the unemployment rate would have remained below 8% throughout the recession. Note
that the decomposition also suggests that house price booms preceding the crisis contributed
significantly to low unemployment rates and economic activity in the late 1980s.
Figure 5: The 1990-91 UK recession - the Contribution of House Price Shocks
House Price Growth Output Growth

0.1
0.02
0.05
0.01
0
0
Counter−factual time−path
−0.05 −0.01 Data
1988.5 1989 1989.5 1990 1990.5 1991 1991.5 1992 1988.5 1989 1989.5 1990 1990.5 1991 1991.5 1992
Corporate Credit Growth Unemployment Rate
0.1
9
0.05 8
7
0
6
−0.05
1988.5 1989 1989.5 1990 1990.5 1991 1991.5 1992 1988.5 1989 1989.5 1990 1990.5 1991 1991.5 1992
Note: To construct the counter-factual time paths of the variables, the contribution of the estimated housing demand shocks
is subtracted from the observables, using the median values from the estimation.

During the recent Great Recession, real UK house prices and real GDP contracted by
about 20% and 7%, respectively, over the period from 2007Q3 to 2009Q2. During the same
period, the unemployment rate rose from 5.3% to 7.7%. To explore the contribution of
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negative house price shocks via the collateral channel to the UK macroeconomy, I compute
what would have been the counter-factual time-path of the six observables, if house price
shocks had been absent.
Figure 6 shows the counter factual paths (blue dash lines) along the actual macroe-
conomic outcome (black solid lines). Without shocks to house prices, we would not have
observed the series of consecutive negative house price growth rates starting from 2007Q3
and reaching a trough of -6.2% in 2008Q4. Adverse housing shocks started feeding in the
macroeconomy by the beginning of 2008: (i) they caused the quarterly output growth rate
to be more than 1% points lower on average through the year 2008, and (ii) contributed to
the rapid increase in the unemployment rate. In fact, the estimation results suggest that
the unemployment rate that reached 7.8% by 2009, would have remained below 6% till the
end of 2009, had house prices not collapsed.
Figure 6: The 2008 UK recession - the Contribution of House Price Shocks
House Price Growth Output Growth

0.01
0.02
0.005
0 0
−0.02 −0.005
−0.01
−0.04
−0.015
Counter−factual time−path
−0.06 −0.02
Data
2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012
Corporate Credit Growth Unemployment Rate
0.06 8
0.04 7.5
0.02 7
0 6.5
−0.02 6
−0.04 5.5
−0.06 5
2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012
Note: To construct the counter-factual time paths of the variables, the contribution of the estimated housing demand shocks
is subtracted from the observables, using the median values from the estimation..
The reason why negative house price shocks had such large effects on the macroeconomy
and on labour markets is because their impact on corporate borrowing via the collateral
channel. In fact, as shown in Figure 6, quarterly corporate credit growth would have re-

mained positive throughout 2008, had house prices not collapsed.
Though the estimation provides strong evidence on the causal link between housing
shocks and the macroeconomy during the recent crisis, this channel does not explain the full
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story, and other mechanisms were also likely to play an important role. For example, shocks
to house prices explain a large part of corporate credit contraction in 2008, but they explain
little of the ensuing tightening of corporate credit. The period 2009-2010 is interpreted by
the estimation as being largely driven by adverse shocks to the collateral constraint (Jermann
and Quadrini, 2012), suggesting that disruptions in financial intermediation (unrelated to
the housing market) were responsible to the continuing corporate credit squeeze. Future
work could extend the present model by modelling financial intermediaries explicitly.
2.4 The Role of Endogenous Job Separation
To explore the role of endogenous job separation in determining the propagation of the
housing shock on labour markets, I set the steady-state value of the endogenous share of
total separation to zero (ρ = ρx ), and re-estimate the model without using separation rates
as an observable. Figure 7 shows the IRFs from the benchmark model along the IRFs from
the estimated model without endogenous separation.
The results are in line with Ramey, den Haan, and Watson (2000) who show that ag-
gregate shocks can be largely amplified by endogenous job separation. Indeed my findings
suggest the impact of a housing shock, that increases house prices by 1%, would have an
0.1% points higher peak impact on output in the model with endogenous separation than
in the model with exogenous separation.20
To put the results into perspective, a housing shock that would lead to a 10% collapse
in house prices, would lead to a peak increase of about 1.3% points in the unemployment
rate after about three quarters, if one allows for endogenous job separation. In contrast, the
same shock would generate ‘only’ a peak increase of 0.5% points in the unemployment rate
over the same horizon, if endogenous separation were absent. This would also imply that
output would fall by 3% when separation is endogenous as opposed to the fall of 2.2-2.6%
20
These results are consistent with Figure 8 of Christiano, Trabandt, and Walentin (2011) that explores
the role of endogenous separation in increasing the propagation of monetary policy shocks.

Figure 7: The Role of Endogenous Job Separation
House Prices Output
0.25
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1
0.2
0.15
0.5 0.1
Exogenous Separation
0.05
Exogenous Separation − re−estimated
Endogenous Separation 0
0
0 5 10 15 20 0 5 10 15 20
Unemployment Rate Job Separation Rate

0 0
−0.5
−0.5
−1
−1
−1.5
−1.5
0 5 10 15 20 0 5 10 15 20
Quarters Quarters
Note: To compute the IRFs for the model with exogenous separation, I set ρ = ρx and use the estimated parameters (black
solid lines) or re-estimate the model without using separation rates as an observable (blue dotted lines). The modes of the
estimated parameters are used to calculate the IRFs for the three models. The IRFs are normalised such that the housing
shocks increases house prices by 1%.
in case of exogenous separation.21

These results may have important implications for other studies that focused on the US
recession. For example, Liu, Miao, and Zha (2016) estimated the impact of housing shocks
on the US unemployment rate but without accounting for the possibility of endogenously
fluctuating separation rates. They find that a shock that leads to a 10% collapse in land
prices would generate an increase of the unemployment rate by 0.34% points, which is close
to my estimate with exogenous separation, shown by the black solid lines in Figure 7 above.
Given that separation rates increased sharply not just in the UK but also in the US during
the Great Recession, recent results for the US may underestimate the true impact of housing
shocks on labour markets by not modelling endogenous separation explicitly.
3 Conclusion
This paper presented evidence on the strong comovement between house prices and labour
market variables in the UK. My paper complements a series of recent studies that reported
similar findings for the US, leading some to the conclusion that “housing really is the business
21
To obtain these number, I used the peak impact on Figure 7, and calculated 0.016 × U × 10 = 1.28 and
0.007 × U × 10 = 0.56, where U = 8% is the steady-state value of the unemployment rate.

cycle” (Leamer, 2015). The comovement between house prices and job separation rates is
particularly striking and is not only a feature of the recent crisis, but characterises at least
the last 30 years of UK business cycles (Figure 1). To the best of my knowledge, this strong
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empirical regularity has not been documented in the literature yet. A DSGE model with
credit constrained firms and search and matching frictions in labour markets can be used to
explain these comovements. I find that shocks to house prices (that are unrelated to other
structural disturbances in the economy such as technology shocks) explain about 10-20%
of output fluctuations and about 20-30% of fluctuations in corporate credit, unemployment
and job separation rates via the collateral channel over the forecast horizon. I find that
ignoring endogenous job separation rates would underestimate the relationship between
housing shocks, collateral and labour market dynamics.
Given the increased importance of labour market variables in the recent policy debate in
the UK as well as the increased financial stability concerns regarding house price dynamics,
it is vital to better understand the drivers of this tight relationship between house prices
and labour markets. The present paper offered one possible narrative that can explain
some fraction of this comovement. Future work should test alternative channels. This
could include the extension of the present model by modelling the household sector in more
detail with special regard to household debt dynamics and related demand channels (Mian,
Sufi, and Verner, 2017). It would also be interesting to extend the current framework with
nominal rigidities in mortgage contracts (Garriga, Kydland, and Sustek, 2017) or in goods
markets (Iacoviello, 2005) in order to study the role of monetary policy in affecting house
prices, collateral values and firm dynamics.

Appendix For Online Publication
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A Additional Figures
Figure 8: The Effects of a House Price Shock in the Regional Proxy SVAR Model
(a) Adding Income to the VAR
House Prices
1
%
0.5
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Inflow into Unemployment

0.2
0
%
−0.2
−0.4
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Income
0.08
0.06
0.04
%
0.02
0
−0.02
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Years
(b) The Effect on the Unemployment Stock
House Prices
1
%
0.5
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Unemployment Stock
0
%
−0.5
−1
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Years
Notes: Income is measured as the weekly male earnings (Hilber and Vermeulen (2016) dataset), the unemployment stock is
the total number of claimants of job seeker’s allowance (Nomisweb). The VAR uses annual data for the 45 pre-1996 counties
spanning the period 1984 - 2007 (1080 observations in total). The shaded area depicts the 95% wild bootstrap confidence
bands (Goncalves and Kilian (2004)) with 10,000 replications.

Figure 9: Results from the Aggregate Recursive SVAR Model: the Effect on the Unemploy-
ment Stock
House Prices Output

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2
0.2
1
%
%
0
0
−0.2
5 10 15 20 5 10 15 20
Unemployment Stock Corporate Debt

2 1.5
0 1
%
%
0.5
−2 0
5 10 15 20 5 10 15 20
Job Finding Rate Separation Rate

1
1
0
%
%
0 −1
−1 −2
5 10 15 20 5 10 15 20
Quarters Quarters
Notes: The aggregate SVAR model is in levels and includes a constant. The identification is with Cholesky triangularisation
with house prices ordered first. The sample period is 1985Q1 - 2015Q1. Unemployment stocks the total number of claimants
of job seeker’s allowance (Nomisweb). The shaded area depicts the 95% confidence bands.
Figure 10: HP-filtered UK House Prices and the Vacancy-Unemployment Ratio
Real House Price Index 0.1

0.15 Vacancy−Unemployment Ratio
0.08
0.1 0.06
0.04
0.05 0.02
%
0
0
−0.02
−0.05 −0.04
−0.06
−0.1 correlation = 0.62
−0.08
1980 1985 1990 1995 2000 2005 2010 2015
Notes: House price data are from Nationwide; unemployment and vacancy data are from the ONS/Nomisweb. The data runs
from 1980Q1 to 2015Q1. The logarithm of both series are HP-filtered with smoothing parameter, = 1600. Consistent vacancy
time-series are not available for the whole sample: data for 1980-2001 are the historical unfilled vacancy series (originally
supplied by the Department for Work and Pensions), and data for 2001-2015 are the vacancy series from the ONS Vacancy
Survey (code: AP2Y). I splice the two series, which may result in unreliable vacancy dynamics around 2001 (when the
correlation with house prices seems to break down).

B The Theoretical Model
B.1 Full Description of the Model

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The model follows Liu, Wang, and Zha (2013) and Liu, Miao, and Zha (2016), and the
modelling of endogenous job separation builds on Ramey, den Haan, and Watson (2000),
Krause and Lubik (2007) and Trigari (2009).
B.1.1 Households
Each household can be thought of as a large extended family with a continuum of employed
and unemployed members. The utility function is written as:
∞
β s At {log (Ch,t − hh Ch,t−1 ) + ϕt log Lh,t − Gt } ,
X
U =E (B.1)
t=0
where Ch,t denotes consumption and hh is the degree of internal habit formation. The
parameter β is the subjective discount factor, land holdings of the household are denoted by
Lh,t with the corresponding taste shifter ϕt referred to as a housing demand shock, whereas
Gt denotes the sum of disutilities from labour supply of the employed household members.
At is an intertemporal preference shock which follows the stationary process:
At = At−1 (1 + λa,t ) , ln λa,t = (1 − ρa ) ln λ̄a + ρa ln λa,t−1 + εa,t . (B.2)
The parameter λ̄a > 0 is a constant, ρa is the degree of persistence. The innovation εa
is iid with variance σa2 . The housing demand shock, which will be the key driver of the
comovement between housing and labour markets, follows the stationary process:
ln ϕt = (1 − ρϕ ) ln ϕ̄ + ρϕ ln ϕt−1 + σϕ εϕ,t , (B.3)
where ϕ̄ > 0 is a constant, ρϕ ∈ (−1, 1) measures the persistence of the land demand shock,
σϕ is the standard deviation of the i.i.d innovation εϕ,t . Following Trigari (2009), each

member has the following disutility from labour:
h1+ν
g (ht , at ) = χ t + 1at , (B.4)
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1+ν
where ht denotes labour hours with scale parameter χ and inverse Frisch elasticity ν. More-
over, at is an idiosyncratic shock to the disutility of working which is assumed to be i.i.d.
across individuals and across time with cumulative distribution function of the lognormal
family F (a) with parameters µa and σa , and density f . The indicator function 1 takes the
value one (zero) if the individual is employed (unemployed). The sum of the disutilities of
employed members is equal to the family’s disutility from supplying labour hours, which is
denoted by Gt in equation B.1. The flow-of-funds constraint is:
St
Ch,t + ql,t (Lh,t − Lh,t−1 ) + = Wt ht Nt + St−1 + bZtp (1 − Nt ) − Tt , (B.5)
Rt
where Wt is the real wage, Rt is the gross riskfree return, St is the purchase in period t of
the loanable bond that pays off one unit of consumption good in all states of the world in
period t + 1, which is known in advance. In period 0, the household starts with S−1 > 0
units of the loanable bonds. Tt refers to lump-sum taxes, and unemployment benefit is
denoted by b which is scaled by Ztp so that it remains stationary relative to labour income.
The household does not choose ht or Nt , as these variables will be determined in the labour
market equilibrium with search and matching frictions. The household’s problem is to choose
a sequence {Ch,t , St , Lh,t }∞
t=0 to maximise its utility. Using the flow-of-funds constraint B.5,
this yields the familiar Euler-equation:
Et Λht,t+1 Rt = 1, (B.6)
h i
where λh,t ≡ At 1
Ch,t −hh Ch,t−1
− Et Chhh,t+1
β(1+λa,t+1 )
−hh Ch,t
is the marginal utility of consumption, and
Λht,t+1 ≡ Et βλh,t+1 /λh,t is the household’s stochastic discount factor. The household’s first-
order condition with respect to residential land is:
At uhl,t
ql,t = Et Λht,t+1 ql,t+1 + ϕt , (B.7)
λh,t

where uhl,t is the marginal utility of residential land owned by the household. Equation B.7
implies that the land price is equal to the sum of the marginal rate of substitution (MRS)
of the household between land and consumption and the expected discounted future land
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price. Note that the housing shock ϕt will take a centre stage in the analysis of the DSGE
model.
B.1.2 Entrepreneurs
The entrepreneur’s utility function is written as:
∞
β s {log (Ce,t − he Ce,t−1 )} ,
X
U =E (B.8)
t=0
where Ce,t denotes the entrepreneur’s consumption and he is the habit persistence. The
entrepreneur is endowed with K−1 units of initial capital stock and L−1,e units of land.
Capital accumulation follows the law of motion:
 !2 
Ω It
Kt = (1 − δ) Kt−1 + 1 − − λ̄I  It , (B.9)
2 It−1
where It is investment, λ̄I denotes the steady-state growth rate of investment, and Ω >
0 is the adjustment cost parameter. The entrepreneur faces the following flow-of-funds
constraint:
It Bt
Ce,t + ql,t (Le,t − Le,t−1 ) + + Bt−1 = + Rk,t Kt−1 + Rl,t Le,t−1 + Πt , (B.10)
Qt Rt
where Bt−1 is the amount of matured entrepreneurial debt and Bt /Rt is the value of new
debt. Rl,t and Rk,t are the rental rates of land and capital, respectively. Qt is the investment-
specific technological change, defined as Qt = Qpt νq,t , where the permanent component Qpt
follows the stochastic process:
Qpt = Qpt−1 λq,t , ln λq,t = (1 − ρq ) ln λ̄q + ρq ln λq,t−1 + σq εq,t , (B.11)
and the transitory component follows the stochastic process:

ln νq,t = ρνq ln νq,t−1 + σνq ενq ,t . (B.12)
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The parameter λ̄q is the steady-state growth rate of Qpt , the parameters ρq and ρνq measure
the degree of persistence. The innovations εq,t and ενq ,t are iid with variances σq2 and σν2q .
The entrepreneur’s ability to obtain credit is subject to the following collateral constraint:
Bt ≤ θt Et [ql,t+1 Le,t + qk,t+1 Kt ] , (B.13)
where qk,t+1 is the shadow value of capital in consumption units, also referred to as Tobin’s
q. The credit constraint B.13 limits the amount of borrowing by a fraction of the gross
value of the collateralisible assets: land and capital. As in Kiyotaki and Moore (1997), the
credit constraint reflects problems of limited contract enforceability. Similar to Liu, Wang,
and Zha (2013) and Liu, Miao, and Zha (2016), the credit constraint will be instrumental
in propagating a shock ϕt to the household’s land demand condition (B.7) into increased
business investment. This is because increased land prices ql,t+1 raise the market value of
collateralisable assets, thereby increasing the borrowing capacity of entrepreneurs.
As in Jermann and Quadrini (2012), the collateral constraint B.13 is subject to exogenous
disturbances:
ln θt = (1 − ρθ ) ln θ + ρθ ln θt−1 + σθ εθ,t , (B.14)
where θ is the steady-state value of θt , and ρθ ∈ (0.1) is the persistence parameter, and εθ,t is
iid with variance σθ2 . The entrepreneur’s problem is to choose a sequence {Ce,t , Bt , Kt , It , Le,t }∞
t=0
to maximise utility.
B.1.3 Labour markets
At the beginning of time t, there are ut unemployed workers looking for jobs, and there are
vt vacancies posted by producers. The technology of matching workers with vacancies is:
mt = ψt uωt vt1−ω , (B.15)

where ω ∈ (0, 1) is the technology scaling parameter. The variable ψt is an exogenous
matching efficiency shock which follows the stationary process:
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ln ψt = (1 − ρψ ) ln ψ̄ + ρψ ln ψt−1 + σψ εψ,t , (B.16)
where ψ̄ > 0 is a constant, ρψ ∈ (−1, 1) measures the persistence and σψ is the standard
deviation of the i.i.d innovation εψ,t .
The probability of an open vacancy being matched with a searching worker is qtv = mt /vt
(job filling rate), whereas the probability of an unemployed worker being matched with
an open vacancy is qtu = mt /ut (job finding rate). Labour market tightness is defined
as Θt = vt /ut . The number of workers employed at the beginning of time t is denoted
by Nt−1 . Before matching takes place, workers lose their jobs with probability ρt before
matching starts at time t. Job separation has an exogenous, constant component, ρx , and
an endogenous component, ρnt :
ρt = ρx + (1 − ρx ) ρnt . (B.17)
The endogenous component of job separation ρnt depends on whether the realisation of the
idiosyncratic preference shock at (equation B.4) is above a certain threshold āt , at which
the employment relationship is discontinued:
ρnt = P r (at > āt ) = 1 − F (āt ) . (B.18)
The number of unemployed workers searching for jobs at time t is written as:
ut = 1 − (1 − ρt ) Nt−1 . (B.19)
The evolution of employment follows the law of motion:
Nt = (1 − ρt ) Nt−1 + mt , (B.20)
which implies that employment at the current period is the sum of the workers that survived
from the last period and the number of matches formed at the beginning of the current

period.22 Given the dynamics of employment, the unemployment rate is determined by the
identity Ut = 1 − Nt .
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B.1.4 Producers
Firms rent capital kt as well as entrepreneurial labour le,t , and produce only if they match
with a worker, using the following technology:
α
φ 1−φ
yt = Zt le,t kt h1−α
t ,
where α ∈ (0, 1) and φ ∈ (0, 1) are the output elasticities of the production factors. The
total factor productivity Zt is composed of a permanent component Ztp and a transitory
component νz,t such that Zt = Ztp νz,t , where the permanent component Ztp follows the
stochastic process:
Ztp = Zt−1
p
λz,t , ln λz,t = (1 − ρz ) ln λ̄z + ρz ln λz,t−1 + σz εz,t , (B.21)
and the transitory component follows the stochastic process:
ln νz,t = ρνz ln νz,t−1 + σνz ενz ,t . (B.22)
The parameter λ̄z is the steady-state growth rate of Ztp , the parameters ρz and ρνz measure
the degree of persistence. The innovations εz,t and ενz ,t are iid with variances σz2 and σν2z .
A firm matched with a worker makes profits from the current-period production, and
continues to receive the value of the employment match (JtF ), if the match survives (with
probability 1 − ρt ) in the next period:
" ˆ āt
#
dF (at+1 )
JtF = πt − wt (at ) ht + Et Λet,t+1 (1 − ρt+1 ) F
Jt+1 (at+1 ) , (B.23)
0 F (āt+1 )
implying that the value of the job depends on profits πt net the real wage, plus the discounted
continuation value. With probability 1 − ρt+1 , the employment relationship survives and
22
The assumption regarding the timing of the probability of separation follows Krause and Lubik (2007),
and the timing of newly formed matches is the same as in Blanchard and Gali (2010) and Liu, Miao, and
Zha (2016). Changing these assumption has little quantitative impact on the estimation. These results are
available upon request.

earns the expected value, whereas with probability ρt+1 , job separation occurs leading to
zero match value. Profits prior to wage payments are determined as follows:
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φ 1−φ
πt = max Zt le,t kt h1−α
t − Rk,t kt − Rl,t le,t , (B.24)
kt ,le,t
where factor prices Rk,t and Rl,t are taken as given. The aggregate wage Wt not only depends
on aggregate factors but also on workers’ idiosyncratic preference shocks:
ˆ āt
dF (at+1 )
Wt = wt (at ) . (B.25)
0 F (āt+1 )
When the firm posts a job vacancy, it pays a vacancy cost κ, and the firm receives the value
JtF when the vacancy is filled (with probability qtv ). If the vacancy is not filled, the firm
continues to have it open next period:
" ˆ āt
#
dF (at+1 )
Vt = −κΓt + Et Λet,t+1 qtv (1 − ρt+1 ) F
Jt+1 (at+1 ) + (1 − qtv ) Vt+1 , (B.26)
0 F (āt+1 )
where the term Γt is the growth factor (defined in Section B.2) to ensure that the ratio
of vacancy cost to output is stationary. Given that free entry reduces the value of an
open vacancy to zero (Vt = 0), equation B.26 implies the following optimality condition for
vacancy posting:
ˆ āt
κΓt dF (at+1 )
v
= Et Λet,t+1 (1 − ρt+1 ) F
Jt+1 (at+1 ) , (B.27)
qt 0 F (āt+1 )
which implies that the optimal vacancy posting is at the point where the benefit of having
a new employment match is equal to the cost of posting and maintaining a vacancy.
B.1.5 Labour markets and Nash bargaining
After a worker is matched with a vacancy, the firm and the worker bargain over the wage
and working hours, defined as the following Nash bargaining problem:
ξt 1−ξt
max JtW − JtU JtF . (B.28)
Wt ,ht

The term JtW in problem B.28 denotes the current value of employment which depends on
the current wage, the disutility of working and the next period probability weighted value
of job loss and of continued employment, written formally as:
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" ˆ āt
#
g (ht , at ) dF (a )
t+1
JtW = wt (at ) ht − + Et Λht,t+1 (1 − ρt+1 ) W
Jt+1 (at+1 ) − U
Jt+1 + U
Jt+1 .
λi,t 0 F (āt+1 )
(B.29)
The term JtU in problem B.28 denotes the current value of unemployment which depends
on the unemployment benefit, the next period probability weighted value of finding a job
and of continued unemployment, written formally as:
" ˆ āt dF (a )
#
t+1
JtU = bΓt + Et Λht,t+1 qtu (1 − ρt+1 ) W
Jt+1 (at+1 ) − U
Jt+1 + U
Jt+1 . (B.30)
0 F (āt+1 )
The term ξt in problem B.28 denotes the worker’s relative bargaining power, which is subject
to exogenous disturbances:
ln ξt = (1 − ρξ ) ln ξ¯t + ρψ ln ξt−1 + σξ εξ,t , (B.31)
where ξ¯ > 0 is the steady-state value of the worker’s relative bargaining power, which will
be estimated. The parameter ρξ ∈ (−1, 1) measures the persistence and σξ is the standard
deviation of the i.i.d innovation εξ,t . The bargaining solution is written as:

ξt JtF = (1 − ξt ) JtW − JtU . (B.32)
Substituting the value of the match to the firm B.23, the vacancy posting condition B.27,
the value of employment B.29 and the value of unemployment B.30 into the bargaining
solution B.32 yields the optimal individual wage rate:
!
g (ht , at )
wt (at ) ht = ξt (πt + κΓt Θt ) + (1 − ξt ) + bΓt , (B.33)
λh,t

where the marginal rate of substation (MRS) between leisure and consumption is equal
to the marginal product of labour, g 0 (ht , at ) /λh,t = (1 − α) yt /ht . Note that the optimal
wage rate is different from the MRS because of the costs related to vacancy posting and
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unemployment benefit in the current search and matching framework. The bargained wage
increases in labour market tightness Θt , the outside option of work b and the realised value
of the idiosyncratic preference shock at . Given B.25, the aggregate wage is written as:

h1+ν ´ āt 
 χ 1+ν +
t
0
at dF (at+1 )
F (āt+1 )
Wt ht = ξt (πt + κΓt Θt ) + (1 − ξt )  + bΓt  , (B.34)

λh,t
Similar to Krause and Lubik (2007) and Trigari (2009), condition B.33 splits the wage
into the costs and benefits of an employment match according to the bargaining power ξt .
Specifically, the wage compensates the worker up to ξt fraction of the firm’s profits and the
saving of hiring costs, and up to (1 − ξt ) fraction of the disutility of labour and the foregone
unemployment benefit.
Endogenous separation depends on the endogenous preference shock threshold āt which
in turn is determined by the zero joint surplus condition. The joint surplus is written as:
St (at ) = JtF + JtW − JtU

" ˆ āt
#
g (ht , at ) dF (at+1 )
= πt − − bΓt + Et Λet,t+1 (1 − ξt+1 qtu ) (1 − ρt+1 ) St+1 (at+1 ) .
λh,t 0 F (āt+1 )
(B.35)
The total surplus equals current revenues net of the labour disutility and the foregone
unemployment benefit plus the continuation value of the employment relationship. Job
separation occurs whenever the realisation of the preference shock reduces the value of the
joint surplus to zero. The condition that determines the threshold value āt is St (āt ) = 0,
which allows condition B.35 to be written as:
g (ht , āt ) 1 − ξt+1 qtu κΓt

πt − − bΓt + = 0, (B.36)
λh,t 1 − ξt+1 qtv
which pins down the threshold value of the preference shock āt , above which job separation
occurs. Finally, using the forward value of B.23, the vacancy posting condition B.27 can be
rewritten as:

" #
κΓt Yt+1 κΓt+1
v
= Et Λet,t+1 (1 − ρt+1 ) (1 − α) − Wt+1 ht+1 + v . (B.37)
qt Nt+1 qt+1
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B.1.6 Market clearing
In a competitive equilibrium, the markets for goods, labour, land and bonds all clear. The
goods market clearing condition is:
It
Ce,t + Ch,t + + κΓt vt = Yt . (B.38)
Qt
The land market clearing condition implies:
Lh,t + Le,t = L̄, (B.39)
where L̄ is the fixed aggregate land endowment. The bond market clearing condition implies:
St = Bt . (B.40)
The capital market clearing condition is given by:
Kt−1 = Nt kt . (B.41)
I abstract from modelling government spending to simplify the analysis, and assume that
all unemployment benefits are financed by lump-sum taxes:
bΓt (1 − Nt ) = Tt .
Aggregate output is given by:
h iα
Yt = Zt (Kt−1 )1−φ (Le,t−1 )φ (ht Nt )1−α . (B.42)
A competitive search equilibrium consists of sequences of prices {Wt , ql,t , qk,t , Rt , Rk,t , Rl,t }∞
t=0
and allocations {Ch,t , Lh,t , Bt }∞ ∞

t=0 for households, allocations {Ce,t , It , Le,t , St , Kt }t=0 for en-
trepreneurs, and allocations {yt , kt , le,t, , ht }∞

t=0 for each firm, and labour market variables

{mt , ut , vt , Nt , qtu , qtv , āt , ρt , ρnt }∞
t=0 such that (i) taking prices as given, the allocations solve
the optimising problems for the household, the entrepreneur and each firm, (ii) new matches
are formed based on the matching technology, with wages and labour hours determined via
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the bilateral Nash-bargaining process, (iii) endogenous separation satisfies the zero joint
surplus condition, and (iv) all markets clear.
B.2 Stationary Equilibrium
I follow Liu, Wang, and Zha (2013) in transforming the trending variables into their sta-
tionary counterparts:
Yt Ch,t Ce,t It Kt Bt
Ỹt ≡ , C̃h,t ≡ , C̃e,t ≡ , I˜t ≡ , K̃t ≡ , B̃t ≡ ,
Γt Γt Γt Qt Γt Qt Γt Γt
Wt ql,t
W̃t ≡ , λ̃h,t ≡ λh,t Γt , λ̃e,t ≡ λe,t Γt , µ̃e,t ≡ µe,t Γt , q̃l,t ≡ , q̃k,t ≡ qk,t Qt ,
Γt Γt
where the trending factor is defined as:
h i 1
(1−φ)α 1−(1−φ)α
Γt ≡ Zt Qt . (B.43)
The stationary equilibrium is characterised by the following system:
B.2.1 Household
1 βhh (1 + λa,t+1 )
λ̃h,t = − Et
C̃h,t − hh C̃h,t−1 Γt−1 /Γt C̃h,t+1 Γt+1 /Γt − hh C̃h,t
1 λ̃h,t+1 Γt
= βEt (1 + λa,t+1 ) (B.44)
Rt λ̃h,t Γt+1
λ̃h,t+1 ϕt
q̃l,t = βEt q̃l,t+1 (1 + λa,t+1 ) + .
λ̃h,t λ̃h,t Lh,t

B.2.2 Entrepreneur
1 βhe
λ̃e,t = − Et
C̃e,t − he C̃e,t−1 C̃e,t+1 gt+1 − he C̃e,t
gt
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1 λ̃e,t+1 Γt µ̃e,t
= βEt +
Rt λ̃e,t Γt+1 λ̃e,t
 !2 
˜t ˜t ˜t
!
Ω I Q t Γt I Q t Γt I Qt Γt
1 = q̃k,t 1 − − λ̄I − Ω ˜ − λ̄I ˜ 
2 I˜t−1 Qt−1 Γt−1 It−1 Qt−1 Γt−1 It−1 Qt−1 Γt−1
!2
I˜t+1 Qt+1 Γt+1 I˜t+1 Qt+1 Γt+1
!
λ̃e,t+1 Qt Γt
+ βΩEt q̃k,t+1 − λ̄I
λ̃e,t Qt+1 Γt+1 I˜t Qt Γt I˜t Qt Γt
(B.45)
" #
λ̃e,t+1 Ỹt+1 Qt Γt µ̃e,t Qt
q̃k,t = βEt α (1 − φ) + q̃k,t+1 (1 − δ) + Et θe,t q̃k,t+1
λ̃e,t K̃t Qt+1 Γt+1 λ̃e,t Qt+1
" #
λ̃e,t+1 Ỹt µ̃e,t Γt+1
q̃l,t = βEt αφ + q̃l,t+1 + Et θt q̃l,t+1 . (B.46)
λ̃e,t Le,t λ̃e,t Γt
 !2 
Qt−1 Γt−1  Ω I˜t Qt Γt
K̃t = (1 − δ) K̃t−1 + 1− − λ̄I  I˜t .
Qt Γt 2 I˜t−1 Qt−1 Γt−1
B.2.3 Labour markets
mt = ψt uωt vt1−ω
mt
qtu =
ut
m t
qtv =
vt (B.47)
qu vt
Θt = tv =
qt ut
Nt = (1 − ρt ) Nt−1 + mt
ut = 1 − (1 − ρt ) Nt−1

" #
κ Ỹt+1 κ
v
= Et Λ̃et,t+1 (1 − ρt+1 ) (1 − α) − W̃t+1 ht+1 + v
qt Nt+1 qt+1
 1+ν
ht ´ āt dF (at+1 ) 
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χ
 1+ν + 0
a t F (āt+1 )
W̃t ht = ξt (π̃t + κΘt ) + (1 − ξt )  + b

λ̃h,t
g (ht , āt ) 1 − ξt+1 qtu κ
π̃t = +b− (B.48)
λ̃h,t 1 − ξt+1 qtv
ρt = 1 − F (āt )
Ut = 1 − Nt
hνt Ỹt
χ = (1 − α) .
λ̃h,t Nt ht
B.2.4 The rest of the model

!− (1−φ)α
Zt Qt 1−(1−φ)α h iα
Ỹt = 1−φ φ
K̃t−1 Le,t−1 (ht Nt )1−α
Zt−1 Qt−1
Ỹt = C̃h,t + C̃e,t + I˜t + κvt

(B.49)
L̄ = Lh,t + Le,t
" #
Γt+1 Qt
B̃t = θt Et q̃l,t+1 Le,t + q̃k,t+1 K̃t .
Γt Qt+1
B.3 Steady-state
B.3.1 Consumers
The steady-state interest rate and shadow prices are:

1 β 1 + λ̄a
=
R gγ
(B.50)
µ̃e β λ̄a
= .
λ̃e gγ
The marginal utility of consumption of the two agents:
 
1  gγ − β 1 + λ̄a hh
λ̃h = 
C̃h gγ − hh
" # (B.51)
1 gγ − βhe
λ̃e = .
C̃e gγ − he

To get the ratio of commercial land to output, use the entrepreneurial land Euler-equation
and the definition B.50:
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q̃l Le αφβ
= . (B.52)
Ỹ 1 − β − β λ̄a θ
So the parameter φ is given by:

q̃l Le
Ỹ
1 − β − β λ̄a θ
φ= , (B.53)
αβ
whereas the scale parameter α is given by capital demand:
1− µ̃e θ
β/gγ
λ̃e
− (1 − δ) K̃
α= . (B.54)
gγ (1 − φ) Ỹ
K̃ q̃l Le
Given the target values for the steady-state Ỹ
and Ỹ
, equations B.53–B.54 pin down φ and
α. The steady-state investment-output ratio can be matched by choosing the appropriate
value for δ:
I˜ 1−δ
=1− .
K̃ λk
Using the definition of the return on capital, the steady-state capital-output ratio is:
K̃ gγ α (1 − φ)
= .
Ỹ Rk e
The investment-output ratio is:
I˜ I˜ K̃ 1 −1

= = 1− β λ̄a θ + β (1 − δ) βα (1 − φ) . (B.55)
Ỹ K̃ Ỹ λk
The binding entrepreneurial credit-constraint implies:
" #
B̃ q̃l Le K̃
=θ g + . (B.56)
Ỹ Ỹ λ̄q Ỹ
Using the definition of the return on entrepreneurial land (Rl = αφY /Lc ), the entrepreneurial
flow-of-funds constraint implies:

I˜
" #
C̃e K̃ 1 1 B̃
= Rk + αφ − − − . (B.57)
Ỹ Ỹ Ỹ g R Ỹ
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The aggregate resource constraint implies:
C̃h C̃e I˜ κv
=1− − − . (B.58)
Ỹ Ỹ Ỹ Ỹ
Lh
To solve for Le
, use the steady-state land demand ratios B.52:

Lh ϕL (gγ − hh ) 1 − β − β λ̄a θ C̃h
= . (B.59)
Le αφβθ (1 − gγ /R) (1 − hh /R) Ỹ
Given the steady-state of the average unemployment rate U , employment is:
N = 1 − U. (B.60)
The matching function:
m = ρN. (B.61)
Endogenous separation rate:

ρ − ρx
ρn = . (B.62)
1 − ρx
The threshold value of the idiosyncratic preference shock:
ā = F −1 (1 − ρn ) . (B.63)
The number of searching workers:
u = 1 − (1 − ρ) N. (B.64)
The job finding rate is:
m
qu = . (B.65)
u
Using the matching function, the number of vacancies:

! 1
m 1−ω
v= . (B.66)
ψuω
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The vacancy filling rate:
m
qv = . (B.67)
v
To derive steady-states levels, use the condition for labour hours:
χhν Ỹ
= (1 − α) . (B.68)
λ̃h Nh
h i
1 C̃h gγ −hh
Using the definition of the shadow price, λ̃h
= Ỹ Ỹ gγ −β (1+λ̄a )hh
, and setting labour
hours h = 1/4 in steady state, the labour scale parameter is given:
(1 − α) N1
χ= h i . (B.69)
C̃h g−hh
h1+ν Ỹ g−β (1+λ̄a )hh
Using the production function:
1−φ α
Ỹ 1−(1−φ)α = (hN )1−α K̃/ Ỹ gγ (Le )φ . (B.70)
Given the level of output B.70, investment, capital and consumption are determined by the
ratios derived above. To obtain a solution for wages, operate on the following labour market
conditions:
h i
Ỹ
κ β (1 − ρ) (1 − α) N − W̃ h
= (B.71)
qv 1 − β (1 − ρ)
ā ν Ỹ ¯u κ
1 − ξq
= (1 − α) − b + (B.72)
λ̃h 1+ν N 1 − ξ¯ q v
! !
Ỹ 1 − α Ỹ H (ā)

W̃ h = ξ¯ (1 − α) + κΘ + 1 − ξ¯ + +b , (B.73)
N 1+ν N λ̃h

where B.71 is vacancy posting equation, B.72 determines the threshold level of the idiosyn-
cratic preference shock, and B.73 is the steady-state wage equation. Some useful derivatives
for the distribution of the idiosyncratic preference shock are as follows. The steady-state
Accepted Article
of the conditional expectation of a given ā can be written using the formula for the partial
expectation of the log-normal distribution:
ˆ ā
!
dF (a) 1 1 2 ln (ā) − µa − σa2

H (ā) ≡ a = exp µa + σa Φ . (B.74)
0 F (ā) F (ā) 2 σa
where Φ is the CDF of the standard normal distribution. The semi-elasticity of the condi-
tional expectation with respect to ā is given by the Leibniz integral rule:
ˆ "ˆ
∂ a dF (a)

ā ā
#
∂H (ā) F (ā) f (ā)  −2 f (ā)
ā =  + ā ā = −adF (a) F (ā) f (ā) + ā ā
∂ā 0 ∂ā F (ā) 0 F (ā)
" #
f (ā) f (ā) āf (ā)
= − H (ā) + ā ā = [ā − H (ā)] .
F (ā) F (ā) F (ā)
(B.75)
Substituting B.71 and B.72 into B.73 and simplifying yields:
!
Ỹ H (ā) − ā
W̃ h = (1 − α) + (1 − β (1 − ρ)) 1 − ξ¯ . (B.76)
N λ̃h
Further complication is that the real wage W̃ in B.76 depends on the shadow price λ̃h which
needs to be expressed. To do so, I use B.51 together with the steady-state of the household’s
budget constraint B.5 to write:
1 1 gγ − hh

= W̃ hN + 1 − B̃ , (B.77)
λ̃h R gγ − β 1 + λ̄a hh
which is substituted into B.76 to yield (after some rearranging) the steady-state solution for
the real wage:

(1−α) Ỹ
1−β(1−ρ) N
+ 1 − ξ¯ [H (ā) − ā] 1 − R1 B̃ς
W̃ h = . (B.78)
1
1−β(1−ρ)
− 1 − ξ¯ [H (ā) − ā] N ς

where ς ≡ (gγ − hh ) / gγ − β 1 + λ̄a hh . Given the level of wages B.78, the vacancy
posting condition B.71 is used to pin down the cost parameter κ. Substituting into B.72

pins down the unemployment benefit parameter b.
Accepted Article
C Data Construction
C.1 Baseline Observables
The baseline DSGE model is estimated on seven UK aggregate time series: real house prices
data
(ql,t ), the inverse of the relative price of investment (qtdata ), real per capita investment
(Itdata ), real per capita output (Ytdata ), lending to corporates (Btdata ), the unemployment rate
(Utdata ) and the job separation rate (ρdata
t ). The sample covers the period from 1985:Q1 to
2015:Q1. The observable series are defined as follows:
data N ationwide
ql,t =
cdef
cdef
qtdata =
idef
inv
Itdata =
popindex
output
Ytdata =
popindex
Bcorp/cdef
Btdata =
popindex
Utdata = U nemprate
ρdata
t = jspissarides
Nationwide: Seasonally adjusted house price index of all houses, derived from Nationwide
lending data for properties at the post survey approval stage.
cdef : Quarterly private consumption deflator, seasonally adjusted (constructed using
ONS codes: (ABJQ + HAYE)/ (ABJR + HAYO)).
idef : Quarterly total gross fixed capital formation deflator, seasonally adjusted (con-
structed using ONS codes: (NPQS+NPJQ)/(NPQT+NPJR)). We use the 2011:Q3 vintage
of this series updated to 2015 using the latest (2015:Q4) vintage. We take this step in order
to omit R&D prices from the data. The ONS changed the treatment of R&D expenditure
from intermediate consumption to gross fixed capital formation as part the implementation
of ESA2010 in 2014. As a result, in the latest vintage of the UK national accounts, relative

investment prices no longer display the downward trend prevalent in other countries. Our
use of an earlier vintage is to capture shifts in the relative price of tangible capital only,
which is more closely aligned with the model definition (not least because intangible capital
Accepted Article
is much harder to collateralise).
popindex: The index of the UK working age (16+) population (source: LFS and ONS;
code: MGSL).
inv: Total gross fixed capital formation, seasonally adjusted, at constant prices, £m
(source: ONS; code: NPQT).
output: Seasonally adjusted Gross Domestic Product chained volume measures at con-
stant prices (source: ONS; code: ABMI).
Bcorp: Quarterly amounts outstanding of monetary financial institutions’ (MFI) sterling
net lending to private non-financial corporations, seasonally adjusted, at current prices, £m.
(source: Bank of England Interactive Database, code: LPQBC57).
Unemprate: LFS unemployment rate in the working age (16+) population (source: ONS;
code: MGSX.Q).
jspissarides: quarterly job separation rates are constructed as described in Petrongolo
and Pissarides (2008): during month t, the continuous-time transition rate from unemploy-
ment to employment is ft and that from employment to unemployment is ρt . The total
unemployment outflow during t, denoted by Ft is given by:
ˆ 1
Ft = [1 − exp (−ft )] Ut + [1 − exp (−ft (1 − τ )) St+τ dτ ] , (C.1)
0
where τ is the the time elapsed since the beginning of the current month, Ut is unemployment
at the start of the period and St+τ is the unemployment inflow at t + τ . Assuming that the
unemployment inflow is uniform during the month, equation C.1 approximates to:
!
1 − exp (−ft )
Ft = [1 − exp (−ft )] Ut + 1 − St , (C.2)
ft
where St is the total inflow during the month. Equation C.2 is solved for ft using available

data for Ft , Ut and St . Similarly, the unemployment inflow rate t is obtained from:
!
1 − exp (−ρt )
St = [1 − exp (−ρt )] Nt + 1 − Ft . (C.3)
Accepted Article
ρt
To get quarterly rates, I average over the monthly values. Decomoposing changes in the
unemployment rate ut into changes in the inflow and outflow rates:
∆ρt ∆ft
∆ut = (1 − ut ) ut−1 − ut (1 − ut−1 ) . (C.4)
ρt−1 ft−1
| {z } | {z }
∆us ∆uf
To obtain the β values in Table 1, one has to calculate:
cov (∆u, ∆uj )

βj = j = s, f. (C.5)
var (∆u)
C.2 Steady State Calibration
To calibrate the steady state of the model I make use of five ratios observable in the data.
Some of the key details in the UK national account estimates of sectoral non-financial
balance sheets are only available from 1997 onwards. Hence, my approach is to compute the
ratios on an annual basis and take the average over the 1997-2014 period for the purpose
of calibration. The same approach is taken in Bahaj, Foulis, and Pinter (2016). Where
the ratio is defined as a stock over a flow, I multiply the ratio by four to convert back to
a quarterly frequency. Data are in current prices. Let variables without time subscripts
denote steady state values.
Capital to output ratio (K/Y ) = 4.99. Capital is defined as total economy fixed assets
less dwellings and less buildings other than dwellings. Output is defined as total econ-
omy gross value added. This ratio is constructed using ONS codes: 4×(NG23-CGLK-
CGMU)/ABML. The entrepreneur’s subjective discount rate β is set to deliver this ratio.

Investment to capital ratio (I/K) = 0.03576. Capital is defined as above. Investment
is defined as total economy gross fixed capital formation. This ratio is constructed using
ONS codes: NPQX/(4×(NG23-CGLK-CGMU)). The depreciation rate δ is set to deliver
Accepted Article
this ratio.
Entreprenuerial land to output ratio ql Le /Y = 2.80. Corporate land is defined as the

total economy dwellings plus total economy buildings other than dwellings less dwellings
owned by the household sector. Output is defined as above. This ratio is constructed using
ONS codes: 4×(CGLK+CGMU-CGRI)/ABML. The production scale parameter φ is set to
deliver this ratio.
Residential land to output ratio ql Lh /Y = 9.28. Residential land is defined as the total
value of dwellings owned by the household sector. Output is defined as above. This ratio
is constructed using ONS codes: 4×CGRI/ABML. The utility scale parameter ϕ̄ is set to
deliver this ratio.
Loan to value ratio θ = B/(ql Le +qk K) = 0.78. We define the total value of corporate debt
(B) as the loan and debt security liabilities of the non-financial corporate sector. Corporate
land plus corporate capital (ql Le + qk K) is defined as the fixed assets of the non-financial
corporate sector. This ratio is constructed using ONS codes: (NOOG+NOPI)/NG2D.
C.3 Estimation
The model is estimated using Bayesian methods as done in Smets and Wouters (2007), Liu,
Wang, and Zha (2013) and Christiano, Motto, and Rostagno (2014) amongst others. The
model parameters are partitioned into three subsets. The first subset of deep parameters is
estimated via Bayesian methods. The second subset is calibrated using steady-state relations
or previous studies. The third subset contains the estimated parameters of shock processes.
n o
The estimated parameters collected in the vector Ψ1 = hh , he , ν, Ω, gy , λ̄q , ξ¯ , consist of
the habit parameters hh and he , the inverse Frisch-elasticity ν, the investment adjustment
cost parameter Ω, the growth rate of per capita output gy and that of investment λ̄q , and
¯ The calibrated parameters, collected in the
the relative bargaining power of workers ξ.

n o
vector Ψ2 = β, λ̄a , χ, α, φ, δ, θ, m, a, µa , σa , κ, b , consist of the subjective discount factors
β and λ̄a , the leisure preference parameter χ, the production parameters α and φ, the
depreciation rate δ, the average loan-to-asset ratio θ, the scale and elasticity parameters
Accepted Article
¯ the mean and the standard deviation of the lognormal
of the matching function m and ξ,
distribution for the idiosyncratic preference shock, µa and σa , the vacancy cost parameter
κ and the unemployment benefit parameter b. The priors on the first subset of parameter
Ψ1 follow Liu, Wang, and Zha (2013).
As for the second subset of parameters Ψ2 , a number of them is used to deliver the
steady-state ratios discussed in Subsection C.2 above. In addition, λ̄a is chosen such that
the annualised real interest rate is 4%. The parameter χ is chosen such that the steady-state
hours is set to h = 0.25 in steady-state. The average labour income share is 70%, α = 0.3.
The elasticity of the matching function is set to a = 0.7 following the estimate of Petrongolo
and Pissarides (2001) for the UK. Following Faccini, Millard, and Zanetti (2013), I set the
steady-state separation to be ρ = 0.03, and following Zanetti (2011) the exogenous fraction
is set to be ρx = 0.02, which implies the steady-state threshold value of the lognormally
distributed idiosyncratic preference shock to be ā = 2.25, given the parameters µa = 0 and
σa = 0.35 as in Trigari (2009).
The steady-state unemployment rate is set to U = 8%, which is lower than the value used
by Faccini, Millard, and Zanetti (2013) (10%) and closer to the average UK unemployment
rate over the 1985Q1-2012Q4 period (7.5%). The implied steady-state job finding rate is
q u = 0.26, which is between the value used by Faccini, Millard, and Zanetti (2013) based on
the Labour Force Survey (0.35) and the average value over the estimation period based on
the claimant count data used by Petrongolo and Pissarides (2008) (0.19). The values for κ
and b are pinned down by the vacancy posting and separation conditions, respectively.
For the third subset of parameters characterising the structural shock processes, I follow
Liu, Wang, and Zha (2013) in adopting agnostic priors and setting a beta distribution for the
persistence parameters that lie with 90% prior probability in the interval [0.0256, 0.7761],
and setting an inverse gamma distribution for the standard deviations that lie with 90%
prior probability in the interval [0.0001, 2]. Table 3 summarises the prior distributions and
presents the estimates at the posterior means together with the 90% probability intervals.

Table 3: MCMC Results: Prior and Posterior Distributions of Structural Parameters
Parameter Prior Posterior

Distribution a b Mean Low High
Accepted Article
hh Beta(a,b) 1.00 2.00 0.0271 0.0000 0.0666
he Beta(a,b) 1.00 2.00 0.5354 0.3700 0.6956
Ω Gamma(a,b) 1.00 0.50 0.1367 0.1066 0.1665
ν Gamma(a,b) 4.00 2.00 2.8184 1.6877 3.8406
ξ¯ Beta(a,b) 1.50 1.50 0.4075 0.3461 0.4715
100 (gγ − 1) Gamma(a,b) 1.86 3.01 0.1492 0.0287 0.2661

100 λ̄q − 1 Gamma(a,b) 1.86 3.01 0.2274 0.0336 0.4015
ρa Beta(a,b) 1.00 2.00 0.9151 0.8913 0.9396
ρz Beta(a,b) 1.00 2.00 0.4809 0.3683 0.5998
ρνz Beta(a,b) 1.00 2.00 0.2295 0.0000 0.5225
ρq Beta(a,b) 1.00 2.00 0.6360 0.5453 0.7294
ρνq Beta(a,b) 1.00 2.00 0.0309 0.0000 0.0709
ρϕ Beta(a,b) 1.00 2.00 0.9995 0.9995 0.9995
ρξ Beta(a,b) 1.00 2.00 0.9772 0.9607 0.9951
ρθ Beta(a,b) 1.00 2.00 0.9672 0.9521 0.9826
ρm Beta(a,b) 1.00 2.00 0.9792 0.9650 0.9948
σa Inv-Gam(a,b) 0.3261 1.45e-04 0.0429 0.0287 0.0564
σz Inv-Gam(a,b) 0.3261 1.45e-04 0.0053 0.0047 0.0059
σνz Inv-Gam(a,b) 0.3261 1.45e-04 0.0001 0.0001 0.0001
σq Inv-Gam(a,b) 0.3261 1.45e-04 0.0072 0.0053 0.0090
σνq Inv-Gam(a,b) 0.3261 1.45e-04 0.0103 0.0089 0.0118
σϕ Inv-Gam(a,b) 0.3261 1.45e-04 0.0446 0.0395 0.0496
σξ Inv-Gam(a,b) 0.3261 1.45e-04 0.0741 0.0614 0.0864
σθ Inv-Gam(a,b) 0.3261 1.45e-04 0.0160 0.0142 0.0177
σm Inv-Gam(a,b) 0.3261 1.45e-04 0.0353 0.0313 0.0393
Note: The parameters a and b denote the shape and scale parameters of the corresponding prior distributions. The High and
Low columns refer to the posterior probability intervals at the 90% level, obtained by running 200,000 MCMC chains.
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House Prices and Job Losses

To explain the mechanism, a general equilibrium model with collateral constraints,

major cause in triggering the 1990 and 2008 recessions.

Keywords: UK business cycle, house prices, collateral, unemployment, job separation

Figure 1: HP-filtered UK House Prices and Job Separation Rates

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1.1 An Aggregate SVAR Model

where Yt is a (T − p) × k matrix, c is a (T − p) × 1 matrix of constants, the term δ is a k × k

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1.3 The Dynamic Effects of House Price Shocks

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House Prices Output

(b) Results from a Regional Proxy SVAR Model

Inflow into Unemployment

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1.4 Decomposing Unemployment Fluctuations

Table 1: Contributions from the Inflow Rate to Unemployment Volatility

2 The Theoretical Model

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2.1 Description of the Model

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The entrepreneur’s utility function is written as:

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Bt ≤ θt Et [ql,t+1 Le,t + qk,t+1 Kt ] , (2.7)

2.1.3 Labour markets

mt = ψt uωt vt1−ω , (2.8)

where ω ∈ (0, 1) is a technology scale parameter, and ψt is an exogenous matching efficiency

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The evolution of employment Nt follows the law of motion Nt = (1 − ρt ) Nt−1 + mt . This

2.1.4 Producers and Nash bargaining

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2.1.6 The concept of housing shocks

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2.2 The Impact and Importance of Housing Shocks

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House Prices Output Investment

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Figure 4: Comparing the DSGE and VAR Identified Housing Shocks

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Figure 5: The 1990-91 UK recession - the Contribution of House Price Shocks

House Price Growth Output Growth

Corporate Credit Growth Unemployment Rate

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House Price Growth Output Growth

Corporate Credit Growth Unemployment Rate

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2.4 The Role of Endogenous Job Separation

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House Prices Output

Unemployment Rate Job Separation Rate

in case of exogenous separation.21

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Inflow into Unemployment

(b) The Effect on the Unemployment Stock

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House Prices Output