Aggregate demand, in contrast, was seen as explaining shorter-term fluctuations around the mostly exogenous supply-determined longer-run trend.1 This conclusion deserves to be reconsidered in light of the failure of the level of economic activity to return to its pre-recession trend in most advanced economies.
This post-crisis experience suggests that changes in aggregate demand may have an appreciable, persistent effect on aggregate supply—that is, on potential output.2 The idea that persistent shortfalls in aggregate demand could adversely affect the supply side of the economy—an effect commonly referred to as hysteresis—is not new; for example, the possibility was discussed back in the mid-1980s with regard to the performance of European labor markets.3 But interest in the topic has increased in light of the persistent slowdown in economic growth seen in many developed economies since the crisis.