DP13409 Slow Recoveries and Unemployment Traps: Monetary Policy in a Time of Hysteresis

Author(s): Sushant Acharya, Julien Bengui, Keshav Dogra, Shu Lin Wee
Publication Date: December 2018
Keyword(s): hysteresis, monetary policy, multiple steady states, path dependence, skill depreciation
JEL(s): E24, E3, E5, J23, J64
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13409

We analyze monetary policy in a model where temporary shocks can permanently scar the economy's productive capacity. Unemployed workers' skill losses generate multiple steady-state unemployment rates. When monetary policy is constrained by the zero bound, large shocks reduce hiring to a point where the economy recovers slowly at best â?? at worst, it falls into a permanent unemployment trap. Since monetary policy is powerless to escape such traps ex-post, it must avoid them ex-ante. The model quantitatively accounts for the slow U.S. recovery following the Great Recession, and suggests that lack of swift monetary accommodation helps explain the European periphery's stagnation.