What is hysteresis in economics in simple terms?

It is the lasting mark a temporary shock leaves on the economy, such as when people unemployed for a long time during a recession lose skills and connections and struggle to find work even after the recession ends.

What does hysteresis mean for economic policy?

If hysteresis is large, ending recessions quickly matters for the long run too. Some economists therefore argue that active monetary and fiscal policy in downturns helps protect future output and employment, and empirical research continues on how large this effect is.

Hysteresis in Economics

📈 Economics By CampusDown Wiki Editorial Team Last updated October 27, 2026

Hysteresis in economics refers to the phenomenon in which temporary shocks, such as recessions, leave lasting marks on economic variables like unemployment or potential output, which do not return to their earlier levels after the shock has passed. The term is borrowed from physics, where a magnet retains its magnetization after an external field is removed. It became widely known through Olivier Blanchard and Lawrence Summers's 1986 explanation of persistently high unemployment in Europe and is an important concept in macroeconomics, labor economics and debates on monetary and fiscal policy.

Contents

1. The concept and European unemployment
2. Channels of hysteresis
3. Evidence and policy debates after the Great Recession
4. FAQ
5. References

The concept and European unemployment

Under Friedman and Phelps's natural rate hypothesis, business cycles move unemployment only temporarily, and in the long run unemployment returns to a natural level set by the structure of the labor market. Phelps (1972) had already noted that unemployment experience could change workers' skills and attitudes and so raise the natural rate itself. Analyzing how unemployment in Europe in the 1970s and 1980s stayed high after shocks had passed, Blanchard and Summers (1986) proposed unemployment hysteresis, in which the unemployment rate depends on its own past path. At the core of their explanation was an insider-outsider model: when wage bargaining centers on the interests of employed insiders, unemployed outsiders are excluded from wage setting and unemployment does not easily fall.

Channels of hysteresis

Researchers have proposed several channels through which temporary shocks leave permanent marks. First, the long-term unemployed lose skills and motivation and are seen as negative signals by employers, making re-employment harder; Layard, Nickell and Jackman (1991) identified rising long-term unemployment as a key factor in persistent European unemployment. Second, investment cut during recessions shrinks the capital stock and slows technological progress, lowering potential output. Third, Dixit (1989) showed that when entry and exit involve sunk costs under uncertainty, firms that leave a market do not readily return even when conditions recover, and Baldwin and Krugman (1989) analyzed how large exchange rate shocks leave persistent effects on trade flows through this mechanism. The concept is closely related to path dependence.

Evidence and policy debates after the Great Recession

Ball (2009) compiled evidence from many countries that the natural rate of unemployment rises along with actual unemployment. Ball (2014) reported that potential output in OECD countries after the 2008 Great Recession fell well below pre-crisis trends, with larger losses in countries that suffered deeper downturns. DeLong and Summers (2012) argued that if hysteresis exists, expansionary fiscal policy in a depressed economy can protect future output and largely pay for itself, and Blanchard, Cerutti and Summers (2015) showed that output frequently fails to return to its prior trend after recessions. Using U.S. local data, Yagan (2019) showed that employment rates in areas hit harder by the Great Recession had not recovered years later. Synthesizing evidence that recessions alter long-run growth paths, Cerra, Fatás and Saxena (2023) questioned the traditional separation of business cycles from long-run growth. The concept is discussed in macroeconomic policy debates alongside Okun's law and time inconsistency.

FAQ

What is hysteresis in economics in simple terms?: It is the lasting mark a temporary shock leaves on the economy, such as when people unemployed for a long time during a recession lose skills and connections and struggle to find work even after the recession ends.
What does hysteresis mean for economic policy?: If hysteresis is large, ending recessions quickly matters for the long run too. Some economists therefore argue that active monetary and fiscal policy in downturns helps protect future output and employment, and empirical research continues on how large this effect is.

Sources reviewed: 2026-10-26

References

Phelps, E. S. (1972). Inflation Policy and Unemployment Theory. New York: Norton.
Dixit, A. (1989). Entry and exit decisions under uncertainty. Journal of Political Economy, 97(3), 620–638.
Baldwin, R., & Krugman, P. (1989). Persistent trade effects of large exchange rate shocks. Quarterly Journal of Economics, 104(4), 635–654.
Blanchard, O. J., & Summers, L. H. (1986). Hysteresis and the European unemployment problem. NBER Macroeconomics Annual, 1, 15–78.
Cross, R. (Ed.) (1988). Unemployment, Hysteresis and the Natural Rate Hypothesis. Oxford: Basil Blackwell.
Layard, R., Nickell, S., & Jackman, R. (1991). Unemployment: Macroeconomic Performance and the Labour Market. Oxford: Oxford University Press.
Ball, L. (2009). Hysteresis in unemployment: Old and new evidence. NBER Working Paper No. 14818.
DeLong, J. B., & Summers, L. H. (2012). Fiscal policy in a depressed economy. Brookings Papers on Economic Activity, 2012(1), 233–297.
Ball, L. (2014). Long-term damage from the Great Recession in OECD countries. European Journal of Economics and Economic Policies, 11(2), 149–160.
Blanchard, O., Cerutti, E., & Summers, L. (2015). Inflation and activity: Two explorations and their monetary policy implications. IMF Working Paper 15/230.
Yagan, D. (2019). Employment hysteresis from the Great Recession. Journal of Political Economy, 127(5), 2505–2558.
Cerra, V., Fatás, A., & Saxena, S. C. (2023). Hysteresis and business cycles. Journal of Economic Literature, 61(1), 181–225.

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This article was last updated on October 27, 2026. It is based on widely recognized original works and textbooks; when citing it in a paper, please check the original sources listed in the references.