Data: uses labor market distortions to explain

Data:

Evidence provides that the 2007-2009 U.S.

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recession differs from past recessions as well as other countries affected by
the recession. Furthermore, according to neoclassical evidence, the United
States attribute their decline in input and output to lower labor input, whereas
lower productivity was the source of recessions of the past and in other
countries. (Ohanian) The neoclassical perspective uses labor market distortions
to explain the U.S. recession, which cause problems between “marginal product
of labor and the marginal rate of substitution between consumption and
leisure.” (Ohanian) In The Economic
Crisis from a Neoclassical Perspective, Lee Ohanian provides evidence that
“per-capita output, consumption, investment, and labor for the 2007-209 recession
and for average peak-to-trough declines over other postwar recessions.”
(Ohanian) Based on the data, the most recent recession was far more severe than
other recessions in labor terms. Similarly the amount of per capita hours
worked from 2007 to 2009 declined by 8.7%. Moreover, Ohanian provides evidence
that assess “real per capita GDP decline 7.2% by from the last quarter of 2007
to third quarter of 2009, compared to an average peak-to-trough decline of
4.4%.” (Ohanian) Lastly, investment and consumption also dropped during the
recession, investment falling by 33.5% and consumption dropping 5.4%.

Otsu and Gerth provide data and graphs that
“plot the mean and boostrapped confidence intervals of de-trended per capita
capital stock, per capital employment, hours worked per worker and total factor
productivity.” Through this they conclude that, after the banking crisis
occurred, capital stock dropped 7%, employment declined by 5%, and hours worked
also fell by 2.5% all over 5 years. Furthermore they “simulate a neoclassical
growth model” to analyze the Great Recession from a neoclassical point of view.

The simulation provides evidence that there was an initial drop in output
during the Great Recession. Otsu and Gerth conclude that the decline in output
has yet to recover, however, the output decline was gradual and the assess that
it was because of “slower adjustments in capital and employment.” (Otsu)

 

Analysis:

Neoclassical economists
emphasize the ability of the invisible hand to push the market back to
equilibrium, without the help of government intervention or any other help. Government
attempting to control the free market only makes things worse. The assumption is that the market
perfectly reflects what is going on in the economy and over time it will
correct itself. A fiscal policy, usually advocated by Keynesians, will not work
in the long run. It may help unemployment in the short run; it will result in
crowding out any stimulus it may provide thus becomes useless. Furthermore, it is
important to compare the Keynesian school of thought to the neoclassical. If
aggregate demand declines and unemployment rises during a recession, Keynesians
would suggest a stimulant government policy while neoclassical economists would
acknowledge that while the policy would be beneficial in short run, that would
not be the case in the long run. The neoclassical belief is that the economy is
self-correcting given the proper amount of time. The amount of time it takes
for the government to implement new policy that will be effective, the
recession will be over or close to it. In fact, some neoclassical economists
would argue that what we observe in the business cycle results from flawed
government policy.  

Since individuals are assumed to be rational, price changes only
occur as a rational response from new information. Neoclassical economists
conclude that the price at a given point in time is the “right price”
because individuals have perfect information, and future prices cannot be
predicted because future information is unknown. This belief created the
efficient market hypothesis (EMH).

EMH is the belief that
prices within financial markets are always correct, given the available
information. (Investopedia) A proponent of this hypothesis is Eugene Fama, who
stated that, “there was no bubble in housing markets, because consumers
had all the information they needed to buy, so the price was right.”
(Cassidy)  Furthermore, Fama denied the existence of a credit bubble that
burst. Therefore, when asked about what created the Great Recession, he
responded that economists cannot know what causes recessions and have never
known, they merely debate what causes them. EMT essentially states that no one
can tell where markets are going exactly. Thus, using the efficient market hypothesis,
neoclassical economics cannot tell much about the financial crash. (Cassidy)

Recessions are thus
viewed as minor interruptions due to imperfection in the market and with time
will correct. This belief also negates the Austrian view that believes in a
cycle of booms and busts, which come from artificial credit booms. Therefore,
neoclassical economists dismiss the Austrian solution of adding credit to the
economy, as it would simply add more fuel to the fire. Following in line with
the hands off government policy, the market should simply be left to set
interest rates on its own and capitalists can decide what investment decisions
are best to make.

Assessments of the
Great Recession using neoclassical business cycle theory find that the
2007-2009 United States recession differs from past recessions experienced by
the nation and other countries that experienced the recession at the same time.

Ohanian provides evidence that concludes that “lower labor input accounts
for virtually all of the decline in income and output in the United
States.” (Ohanian) Furthermore, he finds that the most recent recession is
connected to the labor market distortions that come between consumption and
leisure, which is usually ignored by other models. The marginal rate of substitution
between consumption and leisure was low in comparison to the marginal
product of labor.