Understanding Hysteresis

I presented these slides on Blanchard and Summers 1986 yesterday at the Berkeley Macro lunch. If you are interested in Hysteresis, this is one of the seminal papers in the literature.

Overview 

• Periods of persistently high unemployment are not uncommon events in a broad historical context, yet standard macro theories have a hard time accounting for them
• These periods can be understood in terms of theories of hysteresis that make the long-run unemployment depend on history
• Membership effects (see slides for detail) may well be important sources of hysteresis
• Conclude that membership effects become important in bad times and are not crucially dependent on the presence of unions
• Suggest that enfranchising workers (e.g. work sharing programs) would help and surprising expansionary policies can have very long-lasting benefits

One of the more entertaining parts of the paper was commentary about the last bullet. Blanchard and Summers were focusing on Europe’s persistently high unemployment since the 70s and said that political conditions in Europe not only made it  unlikely anyone would expect expansionary macro policies, but they would also enhance the effectiveness of these policies if they were to occur (since they would be unexpected and not priced in in some sense). In other words, given political constraints, everyone would be surprised if Europe had a stimulus, and the ability to surprise economic agents would provide a positive economic shock that would have very long lasting benefits.

Sounds familiar.