Investment hysteresis and potential output: A post-Keynesian-Kaleckian agent-based approach

•Potential output can suffer permanent losses after major negative demand shocks.•Our agent-based Post-Keynesian model connects demand shocks to economic performances.•Genuine hysteresis implies that temporary demand shocks can have permanent effects.•Debt deleveraging, wage tightening and fiscal consolidation can depress the growth path permanently.

This paper shows that negative economic shocks can have permanent effects on potential output-the amount that can be produced if the economy is at full capacity. In order to do so, we build an agent-based model of growth and distribution where heterogeneous firms adjust capital accumulation discontinuously because of sunk costs and of market constraints. This economy is characterized by a particular form of path dependency, “genuine hysteresis”: the most important temporary shocks affect potential output permanently. The results of the simulations implemented show indeed that austerity policies that trigger debt deleveraging, precautionary saving and wage tightening affect negatively the long-run path of the economy. As a matter of consequence, our paper sheds some light on issues that many European countries have been facing since 2008, and puts into question the possibility for most of these countries to reach the pre-crisis rates of growth. The most likely scenario for Europe in the upcoming decades is therefore a chronicle underutilization of fixed productive capacity and labour force.