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The hysteresis effects of investment shocks in China

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  • Zhu, Zixiang
  • Zhou, Weimin
  • Wen, Yake

Abstract

This paper investigates the permanent effects of investment demand shocks in China, challenging the conventional view in the literature that such shocks are temporary disturbances. Empirically, we identify investment demand shocks with hysteresis effects, which account for a significant share of fluctuations in output, inflation, and investment. Recessions driven by these shocks result in permanent declines in investment, output, employment, and Total Factor Productivity (TFP). To rationalize these empirical patterns, we develop a two-sector New Keynesian DSGE model featuring labor skill accumulation through “learning-by-doing” (hereafter, LBD) and trend processes in both investment demand and supply. The model demonstrates that permanent investment demand shocks induce proportionally larger adjustments in employment and output, aligning with the observed hysteresis effects. Furthermore, our analysis of monetary policy rules reveals that quantity-based rules outperform price-based rules in stabilizing the economy, particularly under permanent investment demand shocks.

Suggested Citation

  • Zhu, Zixiang & Zhou, Weimin & Wen, Yake, 2026. "The hysteresis effects of investment shocks in China," China Economic Review, Elsevier, vol. 96(C).
    • Handle: RePEc:eee:chieco:v:96:y:2026:i:c:s1043951x26000192
    DOI: 10.1016/j.chieco.2026.102669
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