Hysteresis in a New Keynesian Model

This paper examines “hysteresis” in which persistent unemployment takes on structural characteristics over time. Hysteresis is modeled as deterioration in labor market matching efficiency as the average duration of unemployment increases. This is embedded in a simple New Keynesian macro model. A decline in labor market matching efficiency would be consistent with the observed rightward shift of the Beveridge curve since the 2007-09 recession. Hysteresis is shown to lead to larger and more persistent responses of the unemployment rate and unemployment duration to productivity, intertemporal preference and monetary shocks. Hysteresis also generates an increase in the natural rate of unemployment