Historical Hysteresis: Adverse Shocks vs Structural Problems

I started posting last week on the Summers & Blanchard paper, which is on hysteresis and the Unemployment problem in Europe starting in the mid 1970s. Many advocated structural explanations for hysteresis, but Summers & Blanchard looked to the Great Depression period in America when similar structural factors were less present and they found many similarities between the US in the 1930s and the Europe in the mid 1970s and early 80s, suggesting that adverse shocks were more important for explaining what was going on and for understanding what to do about it (i.e. expansionary macro policies).

The finding of so many parallels between the current European Depression and the American depression suggests to us that hysteresis in Europe may be more the result of a long sequence of adverse shocks the the result of structural problems. Perhaps most telling is the observation that the natural rate of unemployment drifted upward following the actual unemployment rate during the American depression as it has in Europe. Given the absence of structural explanations for this drift, the inference that it resulted from high past unemployment seems compelling. So too, the high apparent European natural rate of unemployment may be the result of hysteresis arising in the aftermath of a sequence of adverse shocks. This implies expansionary macroeconomic policies may well work in reducing unemployment in Europe.



About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar. http://faculty.chicagobooth.edu/owen.zidar/index.html
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