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Hysteresis in Potential Output and Monetary Policy

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  • Kienzler, Daniel

    ()

  • Schmid, Kai D.

    ()

Abstract

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.

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Bibliographic Info

Paper provided by University of St. Gallen, School of Finance in its series Working Papers on Finance with number 1328.

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Length: 34 pages
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Handle: RePEc:usg:sfwpfi:2013:28

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Keywords: Monetary Policy; Hysteresis; Potential Output; Output Gap Mismeasurement;

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