Unemployment and Imperfections in Labor and Credit Markets

The difference in unemployment rates between the U.S. and Europe is well documented. In this paper, we develop a model with frictional labor, goods and credit markets to understand how differences in unemployment rates across the U.S. and Europe can be explained by differences in income tax rate, unemployment benefits, monetary policy, and credit market imperfections. Using data between 2001 and 2007, our quantitative analysis shows that among these four factors, labor income taxes is the leading cause of the observed cross-country difference in unemployment rates,followed by unemployment benefits and credit market frictions. Monetary policy is not a contributing factor to the comparatively high unemployment in Europe