Hysteresis and Sources of Aggregate Employment Inertia

It is widely recognized that aggregate employment dynamics is characterized by hysteresis. In the presence of hysteresis the long run level of employment instead of being unique, and history-independent depends on the adjustment path that is taken, which includes the monetary and fiscal measures. It is thus important to study the presence of hysteresis in the macrodynamics of employment to understand whether the recession followed 2007’s financial crisis will have permanent effects, and prospectively to conduct fiscal and monetary policies. The main contribution of this paper is to analyse the relative contribution of the main sources hysteresis (non-convex adjustment costs, uncertainty, and the flexibility of working time arrangements) to the width of the employment band of inaction. For that purpose, a switching employment equation was estimated from a computational implementation of the linear play model of hysteresis. From our results we found significant hysteresis effects in the aggregate employment dynamics caused by the presence of non-convex adjustment costs as uncertainty. We also found that the flexibility firms may have to adjust labour input by varying the number of hours of work per employee helps to mitigate the effect of uncertainty upon the band of inaction.