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  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund
  • | 2 https://isni.org/isni/0000000404811396, International Monetary Fund

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1

One of the earlier explicit references to the word hysteresis in the macroeconomic literature was in the context of labor markets. Clark (1989) used the term to refer to the experience of European labor market during the 1970s and 1980s. The definition of hysteresis used was that of path dependence in steady states “Formally, a dynamic system is said to exhibit hysteresis if it has at least one eigenvalue equal to zero (unity, if specified in discrete time). In such a case, the steady state of the system will depend on the history of the shocks affecting the system. Thus, we should say that unemployment exhibits hysteresis when current unemployment depends on past values with coefficients summing to 1”.

2

Attention to business cycles was rare among economists in previous centuries. Their focus was typically on the understanding of fundamental, long-run economic principles. Mitchell (1927) describes the work of some of the 19th century economists who were concerned with economic fluctuations and their early references to cycles.

3

Kydland and Prescott (1990) build on the earlier criticism that Koopmans (1947) had made of the Burns and Mitchell (1946) methodology as “measurement without theory”.

4

There are alternative view of the cycles such as those proposed by Zarnowitz and summarized in Zarnowitz and Ozyildirim (2006).

5

We refer to GDP in our text for consistency with the recent literature even if many of the early papers were using GNP as the measure of economic activity.

6

Bluedorn and Leigh (2018) find similar result using professional long-term forecasts for 38 advanced and emerging market economies. They find that output forecasts are super-persistent—an unexpected 1 percent upward revision in current period output typically translates into a revision of ten year-ahead forecasted output by about 2 percent in both advanced and emerging markets.

7

See Darné (2009) for the literature on biases in unit root tests due to structural break.

8

Cochrane (1988) established that the variance ratio (variance of cumulative growth over a horizon of many years divided by variance of 1-year growth) for a long time series of US GDP was only one-third.

9

Diebold and Rudebusch (1989) suggested that the rate of convergence of output to trend is very slow – potentially decades – raising questions about the wisdom of treating output as returning to trend within the two-to five-year range commonly used by policy-making institutions and businesses for their forecasts.

10

Blanchard, Cerutti and Summers (2015) build on the work of Martin, Munyan and Wilson (2015), but recognize their contribution is in using a slightly different methodology, looking at the effect of recessions conditional on different types of shocks, and in the interpretation of the results. They rely on a non-parametric method, focused on recessions rather than on fluctuations more generally.

11

Haltmaier (2013) calculates trend output using HP filters, and average growth is compared for the two years preceding a recession, the two years immediately following a recession peak, and the two years after that. She acknowledges the concerns with using an HP filter, but nonetheless employs it to assemble larger dataset.

12

Building on this work, International Monetary Fund (2009) finds that for a broad sample of countries the path of output trend is depressed substantially and persistently following banking crises, with no rebound on average to the pre-crisis trend over the medium term, even as growth returns to pre-crisis rate.

13

This is at odds with Claessens, Kose and Terrones (2012) who find that length and duration of recessions are not affected by credit.

14

King et al. (1987) identify the permanent component in output by assuming that it is also the permanent component in consumption and investment and find that about 60 to 80 percent of the movements in output at the two- to four- year horizon are explained by movements in permanent component. On the other hand, in a VAR framework for GDP and consumption, Cochrane (1994) finds a statistically and economically important transitory component in GDP. For instance, transitory shocks account for an estimated 70–80 percent of variance of GDP growth.

15

Of course, unemployment rates do not need to be a comprehensive measure of labor market slack. Employment rates, that also take into consideration movements in labor force participation, can be better indicators in some circumstances (Murphy and Topel (1997) or Nickell (1997)).

16

Similar observations about the persistence of labor market outcomes had been made earlier by, among others, Clark and Summers (1982) or Ellwood (1982).

17

They refer to a loose definition of hysteresis “where the degree of dependence on the past is very high, where the sum of coefficients is close but not necessarily equal to 1.”

18

Although Sedgley, Burger and Tan (2019) results suggest that the cyclicality of R&D expenditures is fairly symmetric and cannot fully be explained by financial constraints or conditions.

19

Jaimovich and Siu (2012) show evidence for jobless recoveries driven by job polarization, i.e., shrinking concentration of employment in occupations in the middle of the skill distribution.

20

An alternative to generate persistence, at least for some large shocks is to allow for an arbitrary large structural break.

21

However, if technology depreciates, then even permanent exogenous technology shocks would dissipate and lead to stationary output processes.

22

For a good summary of this literature see Barlevy (2004a).

23

As an example, the EU fiscal policy framework heavily depends on the measurement of potential output both when assessing when policy is needed and when measuring the stance of fiscal policy.

24

Benigno and Fornaro (2018) reach similar conclusions in a model where hysteresis is the result of economies getting trapped in a low growth equilibrium. In this case the objective of policy is to avoid such a low-growth equilibrium.

Hysteresis and Business Cycles
Author: Ms. Valerie Cerra, A. Fatas, and Ms. Sweta Chaman Saxena