Discussion paper

DP13409 Slow Recoveries and Unemployment Traps: Monetary Policy in a Time of Hysteresis

We analyze monetary policy in a model where temporary shocks can permanently scar the economy’s productive capacity. Unemployed workers’ skill losses generate multiple steady-state unemployment rates. When monetary policy is constrained by the zero bound, large shocks reduce hiring to a point where the economy recovers slowly at best – at worst, it falls into a permanent unemployment trap. Since monetary policy is powerless to escape such traps ex-post, it must avoid them ex-ante. The model quantitatively accounts for the slow U.S. recovery following the Great Recession, and suggests that lack of swift monetary accommodation helps explain the European periphery’s stagnation.

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Citation

Acharya, S, J Bengui, K Dogra and S Wee (eds) (2018), “DP13409 Slow Recoveries and Unemployment Traps: Monetary Policy in a Time of Hysteresis”, CEPR Press Discussion Paper No. 13409. https://new.cepr.org/publications/dp13409