Testing the Waters of Positive Hysteresis: The Effects of Autonomous Demand Shocks on Inflation, Accumulation, and Labor in the US Economy

CSWP 64 (April 2024)

Author Lorenzo Di Domenico, Santiago José Gahn & Davide Romaniello

Keywords hysteresis, inflation, autonomous demand, NAIRU, potential output

JEL E22, E23, E24, E31, E32, J21, O41

Several authors have developed different arguments on the basis of which a negative shock to aggregate demand could have persistent effects on the level of output, an effect known as hysteresis. In some cases, a positive aggregate demand shock could also have persistent effects, as long as GDP is lower than normal. We provide a substantive classification of the literature on hysteresis. We also present a model in which permanent (and positive) demand shocks have a permanent effect on the level of output and transitory effects on inflation. Finally, we analyze empirically the effects of autonomous demand shocks on unemployment, capacity utilization, inflation, capital (productive capacity) and labor participation rate in the US economy for the 1970Q1-2021Q4 period. Our results indicate that the US economy is extremely flexible to positive demand shocks even during good times, at least during the post Bretton-Woods era.

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