Hysteresis and Business Cycles

IMF Working Papers, May 29, 2020

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Traditionally, economic growth and business cycles have been treated independently.
Hysteresis: dependence of GDP levels on its history of shocks argues for unifying the analysis of growth and cycles.
Renewed interest in hysteresis has been sparked by:
- the persistence of the Global Financial Crisis, and
- fears of a slow recovery from the Covid-19 crisis.

Recent empirical and theoretical literature reviewed in the paper motivate a paradigm shift linking growth and cycles.
The findings have far-reaching conceptual implications: temporary shocks can produce persistent effects on GDP levels (hysteresis).
Specific channels and topics discussed in the literature include:
- Business cycles
- Financial crises
- Labor markets
- Technology
- Unemployment
- Fiscal policy
- Learning by doing
- Liquidity trap
- Physical capital

In recessions:
- Monetary and fiscal policies need to be more active to avoid the permanent scars of a downturn.
In expansions:
- Running a high-pressure economy could have permanent positive effects.