This paper investigates the implications of agency problems on credit markets when vacancy costs require some external financing for the propagation properties of an otherwise standard labor search model. The countercyclical premium on external finance greatly increases the elasticity of vacancies to exogenous innovations such that the model can match the volatility of aggregate unemployment, vacancies and labor market tension. The model is extended to allow for endogenous job separation as there is evidence that contractions are more pronounced at financially constrained firms. This improves the ability of the model to match key labor market statistics while preserving a Bevridge curve between unemployment and vacancies, and magnifies the financial accelerator.
