Estimating Hysteresis Effects

Francesco Furlanetto, Antoine Lepetit, Ørjan Robstad, Juan Rubio-Ramírez, and Pål Ulvedal
Working Paper 2021-24
November 2021

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Abstract: In this paper, we identify demand shocks that can have a permanent effect on output through hysteresis effects. We call these shocks permanent demand shocks. They are found to be quantitatively important in the United States, in particular when the sample includes the Great Recession. Recessions driven by permanent demand shocks lead to a permanent decline in employment and investment, although output per worker is largely unaffected. We find strong evidence that hysteresis transmits through a rise in long-term unemployment and a decline in labor force participation and disproportionately affects the least productive workers.

JEL classification: C32, E24, E32

Key words: hysteresis, structural vector autoregressions, sign restrictions, long-run restrictions, employment, labor productivity, local projections

First Draft: September 2020. This working paper should not be reported as representing the views of Norges Bank, the Board of Governors of the Federal Reserve System, or the Federal Reserve Bank of Atlanta. The views expressed are those of the authors and do not necessarily reflect those of Norges Bank or of the Federal Reserve System. Any remaining errors are the authors' responsibility. The authors would like to thank for useful comments one anonymous referee for the Norges Bank working paper series, Knut Are Aastveit, Jonas Arias, Drago Bergholt, Saroj Bhattarai, Olivier Blanchard, Paolo Bonomolo, Jeff Campbell, Fabio Canova, Yoosoon Chang, Larry Christiano, Todd Clark, Olivier Coibion, Thorsten Drautzburg, Martin Eichenbaum, Stefano Eusepi, Luca Fosso, Luca Gambetti, Cooper Howes, Michel Juillard, Kurt Lunsford, Christian Matthes, Elmar Mertens, Silvia Miranda Agrippino, Nicoló Maffei Faccioli, Florens Odendhal, Francesco Ravazzolo, Øistein Røisland, Aysegul Sahin, Samad Sarferaz, Tatevik Sekhposyan, Sanjay Singh, Anders Vredin, and Hans Christian Wika. They also thank seminar participants at Boston College, the Federal Reserve Bank of Cleveland, Norges Bank, University of Texas-Austin, Texas A&M University, Indiana University, Sveriges Riksbank, Friendly Faces Online seminar series, the 20th Computing in Economics and Finance Conference in Ottawa in June 2019, the 15th Dynare Conference in Lausanne, the sixth Conference on New Developments in Business Cycle Analysis at Norges Bank, the 28th virtual Society for Nonlinear Dynamics and Econometrics conference in Zagreb and the 2021 International Association for Applied Econometrics conference in Rotterdam.

Please address questions regarding content to Francesco Furlanetto, Norges Bank and BI Norwegian Business School, Bankplassen 2, PB 1179 Sentrum, 0107 Oslo, Norway,; Antoine Lepetit, Board of Governors of the Federal Reserve System,; Ørjan Robstad, Norges Bank,; Juan Rubio-Ramírez, Emory University, FEDEA, Federal Reserve Bank of Atlanta, and BBVA Research,; or Pål Ulvedal, Norges Bank, Federal Reserve Bank of Atlanta working papers, including revised versions, are available on the Atlanta Fed's website at Click "Publications" and then "Working Papers."

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