This passage on why the 2008 Recession happened


From Lee E. Ohanian’s “Understanding Economic Crises: The Great Depression and the 2008 Recession”

” A common distortion in many US and other recessions is a productivity distortion… But the 2008 US recession has no distortion in productivity or any other distortions with the exception of a very large deviation in the standard household equilibrium condition that equates the marginal product of labour with the marginal rate of substitution between consumption and leisure.”

“This suggests that if the recession is primarily the consequence of the financial crisis, then it appears to be operating through labour market channels that distort the relationship between the **marginal rate of substitution and the marginal product of labour.** “

Found in Economics.

Anonymous 0 Comments

The household equilibrium condition he’s discussing relates to the tradeoff between labor and leisure. It essentially says that in a perfect, frictionless world people work up until the point that the (marginal) value of what they could buy with some additional labor is equal to the (marginal) value of additional leisure time. If you were at this point and started working more, you could buy some stuff, but you wouldn’t enjoy that stuff as much as just having more non-work time. Conversely, if you were at that point and worked less, you would get more non-work time, but it wouldn’t have as much value to you as the stuff you gave up due to having a lower income.

Ohanian is arguing this condition wasn’t satisfied in 2008. Because he’s talking about a recession, I’d guess his claim is that people were working less than they wanted to. At first this doesn’t seem like much of a shocker (basically every recession is characterized by higher-than-usual unemployment), but the crux of his argument about why 2008 is different is that there doesn’t seem to have been any decrease in how productive people would be if they were to work. You could imagine some other recession where every computer permanently breaks and cannot be replaced. This would have a huge negative effect on the economy and employment, primarily because many workers would become far less productive without computers. However, in 2008 people stayed about as productive as they had always been, but there were still substantial job cuts and unemployment.

There’s no explanation for this suggested in the passage (aside from “labour market channels”), but if I had to find one, I’d start hunting in the credit crunch brought on by the financial disaster. Firms had less borrowing power during that time. This reduced their ability to plan for the future, making them more hesitant to commit to employment relationships that in other times would be obviously good ideas.