Hysteresis in Depressions

It is known that a fall in aggregate demand which is sustained will eventually erode away at aggregate supply and the productive capacity of an economy through a process known as hysteresis.

This happens during economic depressions i.e. long periods of depressed economic activity and means that reflationary policies become less and less effective.

The worst so far have been the Long Depression of 1873-79 and Great Depression of the 1930’s.

But we may be entering into one now….

We’re Seeing the Process

A trait of hysteresis is the rise in the natural rate of unemployment due to deskilling of the labour force through:

  1. Inactivity of the once employed
  2. Emerging generation lacking skills due to youth unemployment

And that is if they are back in work again, some get demoralised and become economically inactive, putting strain on the state..

1 in 5 16-24 year olds are unemployed in the UK, Spain has a terrifying 45%

Reduction in human potential is the most significant, but not the only cause of hysteresis.

Physical Capital Depreciation

With less production than productive capacity, more of an economies physical assets, plants, shops and such sit idle.

While doing so they depreciate, becoming less and less useful when put back into use.Despite the UK being a service and retail based economy (accounting for 77% of GDP) we will still feel this effect through our shops, warehouses offices and malls.

Riots

As we have been seeing, property can be damaged by riots: Depressed economic activity and high unemployment makes rioting more likely ceteris paribus due to social unrest and in other cases, trade union protests.

It’s not only demand that needs to be restored. A nation must be rebuilt and rejuvinated, as well as being able to buy more stuff.

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