Finance and Economics Discussion Series (FEDS)
August 2025 (Revised December 2025)
Hysteresis and the Role of Downward Nominal Wage Rigidity: Evidence from U.S. States
Hie Joo Ahn and Yunjong Eo
Abstract:
This paper empirically investigates the sources of hysteresis, emphasizing the role of downward nominal wage rigidity using U.S. state-level payroll employment growth. U.S. states exhibit heterogeneous recoveries, with L-shaped and U-shaped recessions corresponding to persistent hysteresis and full recovery. L-shaped recessions are importantly driven by demand shocks and reinforced by downward nominal wage rigidity, which prolongs employment losses by raising real wages and deepening downturns. When wage rigidity is strong, expansionary policies are particularly effective in mitigating these effects through labor market adjustment. These mechanisms are validated in a New Keynesian model featuring both hysteresis and downward nominal wage rigidity.
Keywords: Hysteresis, Regional business cycles; L-shaped recession; U-shaped recession; Downward nominal wage rigidity; Monetary policy; Fiscal policy
DOI: https://doi.org/10.17016/FEDS.2025.062r1
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