Working Paper Number
537
Publication Date
3-2021
Abstract
This note provides a model framework for thinking about stabilization policies in the presence of hysteresis after a negative shock like the Covid-19 pandemic. Headline measures of so-called potential GDP published by the Congressional Budget Office represent only one of many possible inflation- neutral trajectories for output. The term potential GDP is misleading since potential implies a unique limit on output. It is much more accurate to consider a range of possible trajectories or multiple equilibria. Repairing the damages from a shock will require overshooting the inflation target and running the economy above its inflation-neutral equilibrium in order to re- store the status quo ante level of output and employment. The model assumes constant trend growth so that path dependence takes the form of pure output-level effects.
DOI
https://doi.org/10.7275/27135954
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