Hysteresis and the Economic Impact of Recessions: A Comparison of the Great Recession and COVID-19

The podcast, featuring Mark Setfield, Professor of Economics at The New School for Social Research, delves into the concept of hysteresis, defined as a type of path dependence where temporary events can have lasting, potentially permanent, effects on future outcomes. Setfield emphasizes that not all temporary effects matter, but rather the more extreme ones, and that hysteresis is not fatalistic, as subsequent interventions can often undo its effects. The core question explored is whether the COVID-19 recession has permanently scarred the US economy, drawing comparisons to the Great Recession. Setfield analyzes the COVID-19 recession's potential hysteresis effects through the lens of aggregate supply and demand, a "Keynesian perspective." On the demand side, he notes that while households initially increased savings due to fear, they have since "dissaved with almost giddy abandon" and re-entered credit markets, suggesting no permanent scarring on aggregate demand formation. On the supply side, he breaks down potential impacts into employment rate, labor force participation, and total population. He finds no permanent structural damage to the labor market's employment rate, which recovered faster than after previous recessions. Labor force participation saw a temporary dip, particularly among older white men bringing forward retirement, but this is not seen as a long-term structural change. The most significant potential long-term hysteresis effect identified from the COVID-19 recession is on total population, due to excess mortality and reduced immigration during the pandemic. This leads to "permanently missing workers" compared to a counterfactual trend. However, Setfield immediately qualifies this by stating that "permanent" only means permanent if "we sit around and do nothing." He explicitly suggests that policy interventions, such as adjusting immigration policy to admit more immigrants, could counteract this supply-side constraint and make up for the lost population. This discussion highlights a crucial distinction between the COVID-19 recession and the Great Recession. The Great Recession, tied to a financial crisis, "broke the model of demand formation" reliant on household borrowing, leading to a persistent impairment in generating demand for potential output and a downward revision of potential output itself—a clear hysteresis effect. In contrast, the COVID-19 recession, while deep, does not appear to have caused similar persistent demand-side scarring. This underscores the importance of the nature of the temporary shock in determining the likelihood and type of hysteresis effects, emphasizing the Keynesian focus on demand generation for full resource utilization.

Hysteresis is essentially a type of path dependence which really just says that events today can have lasting effects on outcomes in the future.

Even temporary effects today can have permanent effects potentially on future outcomes.

Hysteresis is not fatalistic so when we say that the future effects are permanent we don't mean that there's nothing that can be done about them.

Economists are a bit like parrots because all they keep saying is supply and demand supply and demand.

Households have dissaved with almost giddy abandon since the end of the recession they've re-entered credit markets.

The sort of Representative suspect as it were is older white and made and I think the reason for that is fairly easy to explain right older white men those are the folks who disproportionally own wealth in the economy and because they're older they're closer to retirement.

For any given labor force participation rate and any given employment rate if we've got this kind of lost population then what that adds up to is more or less permanently missing workers compared to where we would have been in the absence of the recession.

We only really mean permanent if we sit around and do nothing.

The nature of that recession the fact that it was bound up with a financial crisis it really sort of broke the model of demand formation.

This kind of steady process of revising downwards the sense of potential output in the US economy since 2009.