Endogenous Growth, Skill Obsolescence, and Output Hysteresis in a New Keynesian Model with Unemployment

• Published date: 01 December 2023
• Author: WOLFGANG LECHTHALER,MEWAEL F. TESFASELASSIE
• Date: 01 December 2023
• DOI: http://doi.org/10.1111/jmcb.12979

DOI: 10.1111/jmcb.12979

WOLFGANG LECHTHALER

MEWAEL F. TESFASELASSIE

Endogenous Growth, Skill Obsolescence, and

Output Hysteresis in a New Keynesian Model with

Unemployment

Weembed skill obsolescence and endogenous growth into a New Keynesian

model with search-and-matching frictions. The model accounts for key fea-

tures of the Great Recession: the “productivity puzzle” and the “missing dis-

ination puzzle.” Lower aggregate demand raises long-term unemployment

and the training costs associated with skill obsolescence. Lower aggregate

employment hinders learning-by-doing, which slows down human capital

accumulation, feeding back into even fewer vacancies than justied by the

demand shock alone. These feedback channels mitigate the disinationary

effect of the demand shock while amplifying its contractionary effect on

output. The temporary growth slowdown translates into output hysteresis.

Keywords:endogenous growth, search and matching, unemployment,

monetary policy, output hysteresis

T     recent puz-

zles, associated with the Great Recession and its recovery, which have kept the

attention of policymakers and academics alike: the “missing-(dis)ination” puzzle

and the productivity puzzle. Our explanation rests on a learning-by-doing mecha-

Disclaimer: Opinions expressed by the authors do not necessarily reect the ofcial viewpoint of the

Oesterreichische Nationalbank or of the Eurosystem.

Financial support from the German Science Foundation is gratefully acknowledged. MewaelTesfaselassie

appreciates the Institute for Monetary and Financial Stability (IMFS) for its hospitality during his visit in

the early stage of the research.

Open Access funding enabled and organized by Projekt DEAL.

W L is with the OesterreichischeNationalbank, Austria and Kiel Institute for the

World Economy.E-mail: wolfgang.lechthaler@oenb.at.M F.T is with University of

Antwerp, Belgium and University of Mannheim.E-mail: mewael.tesfaselassie@uantwerpen.be.

Received August 25, 2020; and accepted in revised form August 6, 2021.

Journal of Money, Credit and Banking, Vol. 55, No. 8 (December 2023)

© 2022 The Authors. Journal of Money, Credit and Banking published by Wiley Periodicals

LLC on behalf of Ohio State University.

This is an open access article under the terms of the Creative Commons Attribution-NonCom-

mercial-NoDerivs License, which permits use and distribution in any medium, provided the

original work is properly cited, the use is non-commercial and no modications or adaptations

are made.

2188 :MONEY,CREDIT AND BANKING

nism coupled with retraining costs necessitated by the skill loss of long-term un-

employed. Combining both aspects in a New Keynesian model with search and

matching frictions implies low variability of ination (a atter Phillips curve),deeper

recessions, and permanent scars from recessions in response to a decline in aggre-

gate demand.

Ination has systematically surprised economic forecasters and policymakers, as

it failed to fall signicantly during the Great Recession and later failed to rise during

the recovery. This has led to the so-called missing disination puzzle—the absence

of a dramatic decline in ination during the Great Recession (see, e.g., Hall 2011,

Coibion and Gorodnichenko 2015) followed by the missing ination puzzle (see, e.g.,

Constancio 2015, Bobeica and Jarocinski 2019). It is also reected in a continuous

undershooting of the ination targets of the Federal Reserve and the ECB, part of the

reason both institutions have begun to reviewtheir policy strategies and toolkits (see,

e.g., Lagarde 2020, Powell 2020).

One proposed explanation for the relative stability of ination is based on the idea

of anchored expectations as a result of central bank credibility (e.g., Bernanke 2010).1

Another proposed explanation for the relative stability of ination is the attening of

the Phillips curve (i.e., a weakening of the relationship between economic activity

and ination). Ball and Mazumder (2011), IMF (2013), and Blanchard et al. (2015)

nd that the Phillips curve has attened over time but also that it has become more

stable recently.

The other macroeconomic puzzle associated with the Great Recession is illustrated

by Figure 1, showing the evolutionof U.S. real GDP since 2002 and a trajectory of the

pre-Great Recession trend line. The gure suggests that 10 years after the onset of the

Great Recession actual U.S. real GDP (solid line) is still far below the prerecession

trend (dashed line).

More formally, a number of empirical studies that have examined deep recessions

around the world nd highly persistent effects on output (see, e.g., Cerra and Saxena

2008, IMF 2009, Reinhart and Rogoff 2009). An even starker revelationis the nding

that such recessions leave permanent scars by reducing potential output (e.g., Halt-

maier 2012, Reifschneider et al. 2013, Ball 2014, Martin et al. 2015) and productivity

growth (e.g., Adler et al. 2017, Furceri et al. 2021).

Furthermore, the ongoing economic fallout from the coronavirus-related global

pandemic of 2020, which led to the widespread shutdown of economies around the

world, has reinforced policymakers’ concerns about the long-term damage to the

economy (see, e.g., remarks made by Jerome Powell, the Fed Chair, at the Economic

Update, PIIE virtual event, May 13, 2020). Some have even argued that the macroe-

conomic effects of the pandemic will be worse than the Great Recession (e.g., Rogoff

2020, Roubini 2020).

1.In this regard, Ball and Mazumder (2011) nd evidence that expectations of ination have become

partially anchored at the Fed’s ination target of 2%, although survey measures of household ination

expectations render less support for anchoring (Coibon and Gorodnichenko (2015)).