Estimating Hysteresis Effects

In this paper we identify demand shocks that can have a permanent effect on output through hysteresis effects. We call these shocks permanent demand shocks. They are found to be quantitatively important in the United States, in particular in samples starting in the 1980s. Recessions driven by permanent demand shocks lead to a permanent decline in employment and investment, while output per worker is largely unaffected. We find strong evidence that hysteresis transmits through a rise in long-term unemployment and a decline in labor force participation and disproportionately affects the least productive workers. (JEL C51, E22, E23, E24, E32, J22, J24)