How large are hysteresis effects? Estimates from a Keynesian growth model

Abstract

This paper estimates a demand-led model of macroeconomic growth and fluctuations in which the growth rate of the economy's supply side converges to the growth rate of demand. Convergence happens because labor supply and productivity growth respond to the degree of slack in the economy. Faster demand growth reduces unemployment and stimulates supply. We estimate the model using simulated method of moments and find that after a unit demand shock, labor productivity and labor supply increase by 0.8 and 0.2, respectively, in the long-run. For an economy with labor market slack, our estimates imply that supply growth could accommodate a one percentage point increase in the growth rate of demand with a 0.74 percentage point reduction in the long-run unemployment rate. These hysteresis results are robust to whether or not the Great Recession is included in our sample.