As I mentioned in comments below, Casey Mulligan posted a working paper this weekend that argues this recession is consistent with shifts in labor supply. He gives evidence that this shift is due to increases in the labor wedge.
He gives two causes of increased labor market distortions. The first is talk by the IRS and politicians to be more lax in enforce against economically distressed tax payers. Of course, this would give an incentive to be viewed as “economically distressed” by the IRS. The second distortion unique to this recession is caused by the way distressed mortgages are handled. Rational banks and soft-hearted policy makers will decrease mortgage payments for “economically distressed” individuals. At some levels of income and some sizes of mortgage payments, then, there’s a 100% income tax.
Anyway, there are a million models that could generate labor market wedges. The name of the game is to find one that is also consistent with other salient facts. Mulligan’s mortgage story seems like a stretch but there is one testable implication that I can think of: The housing bubble affected different parts of the country differently. Homeowners in areas most bubbly will be more likely to be given incentives to reduce their labor supply because of offers (or expectations of offers) to decrease mortgage payments conditioned on income or employment status. Here’s a scatter plot of the change in the case-shiller index (a measure of the size of the housing bubble) by the change in the unemployment rate. These are year to year changes from November 2007 to November 2008.
Somebody much better than I at econometrics could see if this simple relation holds for reals.
(h/t Everyday Economist)