Hysteresis in Potential Output and Monetary Policy

Daniel Kienzler and Kai Schmid

Scottish Journal of Political Economy, 2014, vol. 61, issue 4, 371-396

Abstract: type="main" xml:id="sjpe12050-abs-0001">

We show that actively stabilizing economic activity plays a more prominent role in the conduct of monetary policy when potential output is subject to hysteresis. We augment a basic New Keynesian model by hysteresis in potential output and contrast simulation outcomes of this extended model to the standard model. We find that considering hysteresis allows for a more realistic amplification of macroeconomic shocks and persistent movements in output after monetary shocks. Our central policy implication of active output gap stabilization arises from stability analyses and welfare considerations.

Date: 2014
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Working Paper: Hysteresis in Potential Output and Monetary Policy (2013)
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