HYSTERESIS IN A NEW KEYNESIAN MODEL

This paper provides a simple, tractable way of incorporating "hysteresis," in which persistent unemployment takes on structural characteristics, into a macroeconomic model. Hysteresis is modeled as deterioration in labor market matching efficiency as the average duration of unemployment increases. This is embedded in a basic New Keynesian macro model. A decline in labor market matching efficiency would be consistent with the observed rightward shift of the Beveridge curve since the 2007-2009 recession. Hysteresis is shown to lead to larger and more persistent responses of the unemployment rate and unemployment duration to productivity, intertemporal preference, and monetary shocks. Hysteresis also generates an increase in the natural rate of unemployment.