Hysteresis and economics

The goal of this article is to explore the rationale underlying the application of hysteresis to economic models. In particular, we explain why many aspects of real economic systems are hysteretic. The aim is to be explicit about the difficulties encountered when trying to incorporate hysteretic effects into models that can be validated and then used as possible tools for macroeconomic control. The growing appreciation of the ways that memory effects influence the functioning of economic systems is a significant advance in economic thought and, by removing distortions that result from oversimplifying specifications of input-output relations in economics, has the potential to narrow the gap between economic modeling and economic reality. Static hysteresis input-output systems, hysterons, and Preisach models are defined, and the form that macroeconomic models with hysteresis typically take is described. Then some relevant economics background is sketched, and the distinctive nature of models in economics is discussed in detail. In the following central section of the article the results of approximately two decades of hysteresis modeling in economics are summarized.