What is Hysteresis in Economics?

In economics, hysteresis is a phenomenon in that refers to the persistence of an economic effect even after the factors that caused it have been removed. In other words, hysteresis occurs when the economy does not return to its original state after a shock. Recently in the UK hysteresis is likely to have been caused by
  • The 2008 financial crisis
  • Brexit
  • Covid Pandemic
After a recession, the unemployment rate may remain high even after the economy has recovered. This is because some of the unemployed workers may have lost their skills or become discouraged from searching for work. As a result, they may find it difficult to get back into the workforce even when jobs are available.

After a period of high inflation, the inflation rate may remain high even after the underlying factors that caused it have been removed. This is because businesses and workers may come to expect high inflation, and may adjust their behaviour accordingly. As a result, even when the central bank takes steps to reduce inflation, it may take some time for the inflation rate to come down.

Hysteresis in the UK Economy
Hysteresis has been observed in the UK economy on a number of occasions. For example, the unemployment rate remained high for several years after the recession of the early 1980s. Similarly, the inflation rate remained high for several years after the recession of the early 1990s.
There are a number of factors that can contribute to hysteresis in the UK economy. These include:
  • The loss of skills and qualifications among unemployed workers.
  • The mismatch between the skills and qualifications of unemployed workers and the needs of the job market.
  • The reluctance of businesses to hire new workers, even when there are vacancies.
  • The expectation of high inflation among businesses and workers.

Hysteresis in the Economic Cycle

The image shows an economic cycle experiencing a deep recession. Once the recession is over and the economy recovers the economy s now growing at a lower trend rate of growth due to the damage done by the recession.
The impact of hysteresis on the economic cycle
The image shows the economic cycle experiencing a deep recession.  After recovering from the recession the economy is now growing on a new long run trend rate of growth path.  The damage caused by the recession, such as deskilled workers, has caused there to be a significant drop in the trend rate of growth.