 Hysteresis and the welfare costs of recessionsEconomic Modelling, 2021, vol. 95, issue C, 136-144 Abstract: This article explores the implications of hysteresis for the welfare costs of recessions by extending the textbook New Keynesian model to include hysteresis. Hysteresis implies that recessions reduce the level of potential output. Famously Lucas (1987, 2003) argued that the welfare costs of business cycles are negligible without hysteresis. This article demonstrates that the welfare costs of recessions are huge (negligible) in the New Keynesian model with (without) hysteresis. The main finding is that an empirically observed degree of hysteresis increases the welfare costs of a recession by a factor of 121. The results are in contrast with Lucas (1987, 2003), who concluded that only changes in the long-term growth rate of consumption have a significant welfare effect. The welfare costs of recessions can be huge without a change in the long-term growth rate of consumption. Hysteresis therefore implies that stabilization policy should respond forcefully to recessions. Keywords: Business cycles; Costs of recessions; Hysteresis; Stabilization policy (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:95:y:2021:i:c:p:136-144 DOI: 10.1016/j.econmod.2020.12.012 Access Statistics for this article Economic Modelling is currently edited by S. Hall and P. Pauly More articles in Economic Modelling from Elsevier |
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