Economics Commons^™

Policy With Stochastic Hysteresis, Job Boerma, Georgii Riabov, Aleh Tsyvinski

Cowles Foundation Discussion Papers

This paper studies stochastic hysteresis − general dependence on the path of past decisions and shocks. We develop a new methodology for deriving the explicit dynamics of optimal policy with path-dependence and show that stochastic hysteresis changes optimal policy both qualitatively and quantitatively. We showcase our methodology by deriving new results for optimal policy with stochastic habits, tipping points, robustness concerns, limited commitment, and dynamic private information.