Advanced Macroeconomics: Lecture 7 - AS 3 Hysteresis

Question 1

Hsyteresis Explained

Answer 1

There is evidence that macroeconomic shocks affect unemployment equilibrium (Ue), and not just actual unemployment (Ut)

This phenomenon is known as hyteresis.

In economics, if unemployment grows above Ue (that is, Ut > Ue) for an extended period of time, the shock modifies Ue.

The terms “scarring effect, path dependence, & endogenous NAIRU” are used to describe the same idea.

The idea of the “scarring” effect is that after a long enough time out of work, workers lose their skills / willpower / ability to work.

Question 2

Evidence for the Hyteresis hypothesis

Answer 2

The response of the Phillips curve after energy price-shocks in the 80s is a great example.

Energy price shocks –> Inflation –> CB hike rates –> higher unemployment

Inflation stabilized at higher levels of unemployment –> Ue was modified by monetary policy

Question 3

Hysteresis hypothesis: Macroeconomic policy

Answer 3

Hysteresis hypothesis contradicts the WS-PS model’s idea of Ne, because hysteresis model suggests that Ne is not ONLY determined by the labour & goods markets, but also by shocks, and the macroeconomic policies set in response to those shocks.

“The equilibrium of the system depends on the history of the system.” A nice quote to sum up the key idea of hysteresis from Carlin and Soskice, 2005.

Question 4

Long term unemployment: Overview

Answer 4

Layard & Bean 1989 argued that prolonged macroeconomic shocks that increase duration of unemployment thus alter employment equilibrium (Ne).

Evidence to support the “scarring” effect suggested by the hysteresis hypothesis:

Stigmatization. Employers likely to be skeptical. “Why have you been out of work for so long.”

Psychological demotivation.

Question 5

Long term unemployment: Graphically

Answer 5

Question 6

Long term unemployment: Policy implications

Answer 6

Argue we must advocate for policies to support the unemployed in getting new job opportunities:

Job centres
“Welfare-to-work” programmes

Blanchard & Summers propose “hysteresis in reverse” by engineering positive macroeconomic shocks (stimulus) to reduce duration of unemployment and get workers back to work.