Hysteresis: When Recessions Leave Scars

How deep recessions can permanently lower an economy's output and employment by damaging skills, investment and workers' attachment to jobs.

A traditional view of recessions says that once the downturn ends, the economy returns to its previous path. But evidence suggests deep or long recessions can leave lasting damage. Economists call this hysteresis, a term borrowed from physics meaning that a system’s history affects its current state.

How recessions leave scars

Skill loss: workers who are unemployed for a long time may lose skills and connections, making them less employable.
Discouragement: some long-term unemployed people stop looking for work altogether.
Lower investment: firms cut investment in machinery, research and training during recessions, reducing future productive capacity.
Graduating into a recession: studies show that young people who start their careers in a recession earn less for many years afterwards.

Economists Olivier Blanchard and Lawrence Summers popularised the idea in 1986, studying persistently high unemployment in Europe in the 1980s.

Evidence

After the 2008 crisis, output in many rich countries never returned to its pre-crisis trend.
A study by economists Laurence Ball and others found that countries with deeper recessions suffered larger permanent losses in potential output.
Research on workers who lose jobs in mass layoffs finds earnings losses lasting many years.

Policy implications

If recessions cause permanent damage, then:

Acting quickly and strongly against recessions is more valuable, since preventing unemployment avoids long-term scars.
Policies such as job retention schemes, used widely in Europe during the pandemic, may help by keeping workers attached to employers.
Running the economy hot, allowing demand to stay strong, may pull discouraged workers back into jobs, reversing some damage.

The rapid recovery of employment in the United States after 2020, supported by large stimulus, was seen by some economists as evidence that strong policy can limit scarring.

The graduate in a bad year

A student graduates during a recession and can only find a lower-paying job outside their field. Years later, even after the economy recovers, they are still earning less than classmates who graduated a few years later, because they started lower and missed early career-building experience.

Thinking recessions are temporary dips with no lasting cost

Deep recessions can permanently lower output and earnings. This is why many economists argue for strong, quick responses to downturns.

Key takeaways

Hysteresis means recessions can cause lasting damage to output and employment.
Skill loss, discouragement, lower investment and scarred careers are channels.
After 2008, many economies never returned to their previous trend.
The idea supports acting quickly against recessions and keeping workers attached to jobs.