Hysteresis in LATAM. Assessing the long-term impact of monetary policy and LMI on unemployment during the 2010s

The aim of this paper is to investigate the existence of hysteresis in Latin American (LATAM) economies. Hysteresis refers to the effect that shocks and macroeconomic policies, such as monetary policy, can have in the unemployment equilibrium of the economy. Evidence from OECD economies has grown in recent years, however, existing literature for Latin American countries is very limited. We extend this incipient literature, by providing a formal test of the relationship between macroeconomic policies, in this case, monetary policy, and unemployment. To do so, we built a panel of ten countries, namely, Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru and Uruguay, covering the period between 2010 and 2022. We test the hysteresis hypothesis using a Panel-ARDL approach controlling for key Labour Market Institutions (LMI), such as, benefits, labour taxation, union power and minimum wages. Our findings indicate that interest rates set by Central Banks, significantly affect unemployment in the long run, hence, providing support to the hysteresis hypothesis. As per our results 1% increase in interest rates lead to a rise in equilibrium between 0.40 and 0.79 percentage points. Furthermore, our results are robust to a battery of tests including alternative LMIs definitions, accounting for heterogeneity across economies, and changes to the geographical and time scope. We also use Instrumental Variables analysis to rule out endogeneity. Our findings question the consensus among Central Banks and international institutions, that monetary policy can be used to manage inflation and exchange rates at no cost for the real equilibria of the economy. Furthermore, our results question the renewed interest in labour market structural reforms in the region.