Detecting unemployment hysteresis: A simultaneous unobserved components model with Markov switching

•Markov-switching unobserved components framework with asymmetric spillovers.•Upward trend in German unemployment fully explained by hysteresis.•Both hysteresis and structural unemployment reduced after institutional reforms.•U.S. unemployment not driven by hysteresis effects.

We construct a new Markov-switching unobserved components framework for analysing hysteresis effects, featuring trend-cycle decomposition, identification of spillovers between the components and asymmetry over the business cycle. The decades-long upward trend in German unemployment is fully explained by hysteresis. The Great Recession was well absorbed because both hysteresis and structural unemployment were substantially reduced after institutional reforms. In contrast, U.S. unemployment was not driven by hysteresis effects.