This dissertation analyzes the phenomena of hysteresis in the Canadian economy from an open economy approach which combines studies of hysteresis in the international trade and the domestic labour market. In the theoretical analysis, two models for a small open economy are developed: one for the aggregate demand side and one for the aggregate supply side. The first one presents a hysteretic IS-LM-BP model which shows that trade hysteresis could result in a vertical IS curve and bend the aggregate demand curve until it is infinitely inelastic. A very steep aggregate demand curve explains the demand side hysteresis in the domestic economy. The second model derives an open economy version of the Phillips curve by allowing the exchange rate to enter the right-hand-side of the equation, and provides a theoretical base for empirical testing. The empirical analysis of this study tests trade hysteresis and estimates the Phillips curve. Following the widely used approach of trade hysteresis testing, the unit root and the cointegration tests are performed on the series of net exports and the exchange rate for the data sets of the US, the OECD, and the rest of the world. The results show that both of net exports and the exchange rate followed random walk, and there is no cointegration between the two series which is consistent with trade hysteresis. The Phillips curve estimation includes two steps. Step one uses the causality test to show that changes in the exchange rate cause changes in the inflation rate, but not vice versa, which supports the open economy version of the Phillips curve. The next step is to estimate the Phillips curve, and the degree of hysteresis is calculated from the results of the estimation. In alternative estimations with different measurements of the unemployment rate, different data periods, and different data frequencies, the results suggest that hysteresis has been significant in the Canadian economy.

The deep recession and slow recovery of the Canadian economy in the 1980s and the lengthy recession of the early 1990s raised serious questions about economic policy making. The steady worsening of Canadian unemployment rates led some economists to doubt the traditional view that the national economy is by nature self-correcting and to endorse the concept of hysteresis - the idea that the unemployment rate may display no tendency to return to an unchanging natural rate. Such hysteresis would have important and far-reaching implications for economic policy, particularly monetary policy. Jones provides an overview of leading theories of hysteresis and examines international and Canadian evidence from both microeconomic and macroeconomic perspectives. He extends the econometric analysis of hysteresis at both the micro and macro levels and concludes that while there is some evidence of dependence in Canada, the overall picture is not one of hysteresis.

Traditionally, economic growth and business cycles have been treated independently. However, the dependence of GDP levels on its history of shocks, what economists refer to as “hysteresis,” argues for unifying the analysis of growth and cycles. In this paper, we review the recent empirical and theoretical literature that motivate this paradigm shift. The renewed interest in hysteresis has been sparked by the persistence of the Global Financial Crisis and fears of a slow recovery from the Covid-19 crisis. The findings of the recent literature have far-reaching conceptual and policy implications. In recessions, monetary and fiscal policies need to be more active to avoid the permanent scars of a downturn. And in good times, running a high-pressure economy could have permanent positive effects.