Hysteresis

Published Oct 25, 2023

Definition of Hysteresis

Hysteresis refers to a phenomenon in which the effects of past events or conditions persist and have a lasting impact on the present and future state of a system. In economics, it is often used to describe the situation where the current state of the economy is influenced by its past performance or shocks, and is not solely determined by current conditions. This means that the trajectory of the economy is path-dependent and can result in persistent changes in output, employment, and other economic variables.

Example

Let’s consider the example of an economic recession. During a recession, there is a significant contraction in economic activity, leading to high unemployment rates, reduced consumer spending, and decreased business investment. These negative economic conditions can create a downward spiral, as businesses lay off workers, consumers cut back on their spending, and investments are postponed.

Now, even if the factors that initially triggered the recession improve, such as increased consumer confidence or government stimulus measures, the economy may not immediately return to its pre-recession levels of output and employment. This is because hysteresis effects can persist and cause long-term damage to the economy. For example, workers who have been unemployed for an extended period may lose their skills or become discouraged, reducing their future productivity and ability to find employment. Similarly, businesses that have shut down during the recession may not reopen, leading to a loss of productive capacity and investment.

As a result, the economy may experience a lower potential output and higher natural rate of unemployment even after the recession ends. This demonstrates the hysteresis effect, where the past condition of the economy has a lasting impact on its present and future state.

Why Hysteresis Matters

Understanding hysteresis is crucial for policymakers and economists as it highlights the importance of proactive measures to mitigate the negative effects of recessions and other economic shocks. If the effects of past events are allowed to persist, it can hinder the full recovery of the economy and result in long-term economic underperformance. Policies that aim to break the cycle of hysteresis may include targeted training and re-skilling programs for the unemployed, investment in infrastructure to stimulate demand and create jobs, and measures to promote business innovation and investment. By addressing hysteresis, policymakers can help promote a more sustainable and robust economy.