Working Paper: CEPR ID: DP13409
Authors: Sushant Acharya; Julien Bengui; Keshav Dogra; Shu Lin Wee
Abstract: 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.
Keywords: hysteresis; path dependence; monetary policy; multiple steady states; skill depreciation
JEL Codes: E24; E3; E5; J23; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy (E52) | Unemployment outcomes (J65) |
| Temporary shocks (E32) | Unemployment outcomes (J65) |
| Large shocks (E32) | Reduced hiring (J63) |
| Reduced hiring (J63) | Slow economic recovery (E65) |
| Slow economic recovery (E65) | Permanent unemployment trap (J64) |
| Accommodative monetary policy (E52) | Prevent hysteresis (C69) |
| Delayed monetary policy (E52) | Unemployment trap (J64) |
| Nominal rigidities and ZLB (E31) | Lasting effects of temporary shocks (E32) |
| Commitment to higher future inflation (E31) | Mitigate rise in unemployment (J68) |
| Timely intervention (C41) | Effective escape from unemployment trap (J68) |
| Delayed monetary policy (E52) | High unemployment rates (J64) |
| Unemployment trap (J64) | Deteriorating skill composition (J24) |