Involuntary Unemployment in a Path-Dependent System: The Case of Strong Hysteresis

Abstract

Hysteresis has been introduced in economics as an alternative to the dominant mainstream models based on the various declensions of the Natural Rate of Unemployment and of the NAIRU. By contrast with the improper interpretations of the concept of hysteresis, many Post-Keynesians have tried to exploit the genuine hysteresis concept used in physics and in other sciences, in order to try understanding the persistence of high unemployment rates in Europe. Hysteresis is one of the most important forms of path dependency in economics. In the presence of hysteresis, the economic system will be characterised by changing equilibria in the aftermath of non-dominated aggregate shocks. In these conditions, the equilibrium unemployment rates change on the basis of the history of past non-dominated aggregate shocks. Rather surprisingly, the authors that have worked in this field up to now have forgotten to examine one of its most important implications: in the presence of hysteresis, unemployment is mainly an involuntary phenomenon. After summing up the main results of the debates on the meaning and the relevance of main definitions of hysteresis in the literature, and underlining the relevance of the concept of genuine hysteresis, we propose a theoretical model for understanding hysteresis in unemployment on the basis of Keynes’s concept of effective demand.

The author wishes to thank Mark Setterfield and all the other participants in the 5th International Conference on Developments in Economic Theory and Policy for their helpful and relevant remarks on a preliminary version of this chapter.