DP14531 Hysteresis and Business Cycles

Author(s): Valerie Cerra, Antonio Fatás, Sweta Saxena
Publication Date: March 2020
Keyword(s): Booms, business cycles, Crises, growth, hysteresis, Macroeconomic Policy, Persistence, recovery, Stabilization Policy
JEL(s): E32, E60, O47
Programme Areas: International Macroeconomics and Finance, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14531

Traditionally, economic growth and business cycles have been treated independently. However, the dependence of GDP levels on its history of shocks, what economists refer to as "hysteresis," argues for unifying the analysis of growth and cycles. In this paper, we review the recent empirical and theoretical literature that motivate this paradigm shift. The renewed interest in hysteresis has been sparked by the persistence of the Global Financial Crisis, as GDP in advanced economies remains far below the pre-crisis trends. The findings of the recent literature have far-reaching conceptual and policy implications. In recessions, monetary and fiscal policies need to be more active to avoid the permanent scars of a downturn. And in good times, running a high-pressure economy could have permanent positive effects.