Schmid, Kai D.
We show that actively stabilizing economic activity plays a more prominent role in the conduct of monetary policy when potential output is subject to hysteresis. We augment a basic New Keynesian model by hysteresis in potential output and contrast simulation outcomes of this extended model to the standard model. We find that considering hysteresis allows for a more realistic propagation of macroeconomic shocks and persistent movements in output after monetary shocks. Our central policy implication of active output gap stabilization arises from stability analyses and welfare considerations.
Movements in long-term unemployment (LTU) exhibit a substantial cyclical component. I develop a business cycle model featuring labor market frictions and skill loss during unemployment to capture various stylized facts about the cyclical behavior of long-term unemployment. I find that the skill loss mechanism helps reproduce negative duration dependence, high persistence in unemployment and output, volatility patterns across macroeconomic variables and the behavior of the incidence of LTU around business cycle turning points. Optimal monetary policy in the presence of skill loss during unemployment calls for a softer reaction to inflation after productivity shocks.
The monetary authority accepts more inflation in order to avoid high skill loss during unemployment which would reduce production and hence consumption possibilities.