Hysteresis and Cost-Push Inflation: which Implications for Monetary Policy?

The spectre of inflation is haunting Europe. In 2021, inflation rose to levels not seen since the 1980s. The increase in energy prices is mostly to blame. What is the proper monetary policy stance to adopt in this context? Several arguments are at variance with the effectiveness of the standard restrictive monetary policy. On the one hand, the presence of ‘hysteresis’ suggests that a restrictive monetary policy can have long-lasting negative effects determining persistently lower employment and economic activity levels. Moreover, the cost-push nature of inflation casts doubt on the effectiveness of current monetary policy. This paper argues that trying to deflate the econo my by raising interest rates and limiting the growth of demand may be self-defeating. Therefore, after showing the meaning and the functioning of hysteresis, we argue that restrictive monetary policy can produce a persistent negative effect on output without reducing the inflation rate.