Revisiting the hysteresis hypothesis: an ARIMAX approach

Abstract

The 2008 financial crisis saw a resurgence of interest in the hysteresis hypothesis, which was subsequently reflected in policy responses to the COVID-19 and cost-of-living crises. In this paper, we present new evidence in favour of the hysteresis hypothesis for Germany, France, and the United Kingdom, using a dataset that spans from 1960 to 2019. Our model is based on the popular unobserved components approach to estimating the degree of hysteresis, which is generalised to permit a reduced form Phillips curve that takes the form of an ARIMAX model. Our results are robust to ARCH effects and varying the sample span. They support contemporary warnings of the risk of scarring effects following the COVID-19 crisis, long-standing Post-Keynesian models of hysteresis, and the recent resurgence of mainstream interest in hysteresis.