Hysteresis in unemployment: A confidence channel

• Date: 01 March 2019
• Author: Dmitry Plotnikov
• Published date: 01 March 2019
• DOI: http://doi.org/10.1111/ijet.12207

doi: 10.1111/ijet.12207

Hysteresis in unemployment: A confidence channel

Dmitry Plotnikov∗

This paper develops a general equilibrium rational expectations model with search and mul-

tiple equilibria where aggregate shocks have a permanent effect on the unemployment rate. If

agents’ wealth decreases, for either fundamental (productivity) or non-fundamental (sunspot)

reasons, the unemployment rate can increase for a potentially indefinite period. This makes the

unemployment rate dynamics path dependent.

Key wor ds sunspot, hysteresis, unemployment, jobless recovery

JEL classification E20, E30, E32

Accepted 8 August2018

1 Introduction

This paper constructs a model that aims to explain persistent unemployment dynamics in the USA

after the 2008 crisis together with the rest of the post-war period. Specifically, after the crisis the

unemployment rate was highly persistent and remained above 8% for more than 15 quarters. How

was this recession different from the other 11 post-war recessions?Can it be explained w ithin a single

framework together with the other post-war recessions?

Figure 1 shows that employment dynamics in post-war recessions varied significantly.The x-axis

corresponds to the number of months from peak employment in the corresponding recession.1

The y-axis measures the employment drop in percent from the peak. Zero is normalized to be

peak employment in every recession. It follows from Figure 1 that, prior to 1990, recoveries in

employment were quick and took less than 8 quarters. Since 1990 employment recoveries havebeen

much more sluggish. For this reason some economists dubbed the last three recoveries “jobless.”2

For the purposes of this paper, by “jobless” recovery I mean persistent unemployment after the end

of the recession together with recovered real growth.

Several reasons for the employment sluggishness in the last three recoveries have been pro-

posed in the literature. Jaimovich and Siu (2018) connect this phenomenon to that of job polariza-

tion and argue that mechanization and technological advances contributed to the disappearance of

∗International Monetary Fund, WashingtonDC, USA. Email: dplotnikov@imf.org

The views expressed in this paper are those of the author and do not necessarily represent the views of the IMF, its

Executive Board, or IMF management. The author wishes to thank Ariel Burstein, Francisco Buera, Andrew Atkeson,

Pablo Fajgelbaum, Jang-TingGuo, Lee Ohanian, and Aaron Tornell for their detailed comments. The author is especially

thankful to Roger Farmer for his time and invaluable advice.

1By peak employment I mean the highest total non-farm payrolls [PAYEMS]. See, for example, the St. Louis FRED

database.

2Gal´

iet al. (2012) use the term “slow recoveries” to emphasize that there was no structural break in the relationship

between US gross domestic product and employment in 1990. My model is entirely consistent with this evidence as it

can generate both regular and jobless recoveries.

International Journal of Economic Theory 15 (2019) 109–127 © IAET 109

International Journal of Economic Theory

Hysteresis in unemployment Dmitry Plotnikov

Figure 1 Employment dynamics in all post-war recessions

in the United States. Zero is normalized to be peak employmentw ithin or prior to every NBER recession.

Source: Total Nonfarm Employment, US Bureauof Labor Statistics (https://fred.stlouisfed.org/series/PAYEMS).

middle-income jobs during the last three recessions. Shimer (2012) emphasizes the importance of

wage rigidities. Berger (2018) suggests that a decrease in union power in the 1980s made it easier for

firms to lay off less productive workers during the last recessions. Wiczer (2015) highlights the im-

portance of heterogeneity of unemployment spells across different occupations and sectors. Albanesi

(2017) argues that “jobless” recoveries are actually the norm, but were masked previously by the

increase in female labor force participation in the USA up until around the 1990s, the time of the

first registered “jobless” recovery.

In this paper I focus on wealth changes as a reason for the speed of an employment recovery.What

I mean by this is that the last three recessions and especially the Great Recessionwere associated with

large wealth losses. For example, during the Great Recession, the real net worth of US households

and non-profit organizations declined by 20% within one year, and the decline from peak tot rough

of the last recession was larger than 25%.3

Table 1 suggests that throughout the post-war period employment recovered more slowly after

recessions with wealth losses relative to recessions with no wealth losses, exceptthe 1974 recession.4

The first row of Table 1 indicates the number of months it took employment to recover to the pre-

recession level (see Figure 1). The second row of Table 1 summarizes average quarterly growth rates

3I define real net worth as Board of Governors of the Federal Reserve System (US), Households and Nonprofit Organi-

zations; Net Worth, Level[TNWBSHNO] deflated by the CPI index for All Urban Consumers: All Items [CPIAUCSL].

Defined as the difference between household and non-profitorganizations’ assets and liabilities, it includes non-financial

assets such as realestate, consumer durable goods, equipment value as well as financial assets such as pension entitlements,

equity and debt instruments.

4Wealthdata for the 1948 recession are not available.

110 International Journal of Economic Theory 15 (2019) 109–127 © IAET