TAILIEUCHUNG - The Economic Crisis from a Neoclassical Perspective

Economic crises are historically times of industrial renewal. Less efficient firms fail while more dynamic ones emerge and expand. Creative destruction is an essential engine of long term efficiency in market economies, and it intensifies in downturns. Available data for many OECD countries point to a sharp increase in bankruptcies and business failures in recent months. New business models and new technologies, particularly those allowing a reduction in cost, often arise in downturns, as was the case with low-cost airlines which grew out of the recession of the early 1990s. As dominant players weaken, they open space for new players. | Journal of Economic Perspectives Volume 24 Number 4 Fall 2010 Pages 45-66 The Economic Crisis from a Neoclassical Perspective Lee E. Ohanian The . recession from 2007-2009 differs considerably from other postwar . recessions and from the parallel recessions in other high-income countries like Canada France Germany Italy Japan and the United Kingdom. In the United States lower output and income is exclusively due to a large decline in labor input. In contrast lower output and income in many other . recessions and in the 2007-2009 recession in these other countries are due to significant productivity declines and much smaller declines in labor input. Figure 1 shows quarterly per capita hours worked in the United States between 1956-Q1 and 2009-Q2 with shading indicating recessions according to the dates assigned by the National Bureau of Economic Research. The figure highlights the abnormally large labor decline in the 2007-2009 recession relative to earlier recession dates. The analysis presented here indicates that the 2007-2009 recession is not well-understood within current classes of economic models including both standard real business cycle models and perhaps surprisingly also including models in which financial distress reduces economic activity. Specifically the 2007-2009 . recession and its aftermath requires much like understanding the Great Depression a theory for why the marginal rate of substitution between consumption and leisure was so low relative to the marginal product of labor. This means that labor input during the 2007-2009 recession in the United States was far below the level consistent with the marginal product of labor and indicates that the labor input would have changed very little after 2007 in the absence of this deviation. Lee E. Ohanian is Professor of Economics and Director Ettinger Family Program in Macroeconomic Research both at the University of California at Los Angeles Los Angeles California. He is also Associate .

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