Christina D. Romer:
Hysteresis Effects: Fiscal changes may also be particularly powerful in times like the present for another reason, and in a very different way. When unemployment has been high for an extended period, the risks that normal unemployment may rise over the long run increase….
[A]s high unemployment has persisted in the United States following the financial crisis, analysts have increased their estimates of the natural rate.… [A]nalysts did not raise their estimates noticeably in response to the large rise in unemployment early in the crisis; it was only when unemployment remained elevated for a substantial period that their estimates rose.
These rising estimates of the natural rate do not prove that there is a hysteresis effect that can be addressed by fiscal policy…. But prolonged high unemployment (due at least in part to inadequate policy responses) is likely part of the story…. Fiscal contraction would not only slow the recovery, it could cause unemployment to be permanently higher. Conversely, fiscal expansion might not only lower unemployment in the near term, but prevent a lasting rise in the natural rate…
