A Simple Model of Hysteresis in Employment under Exchange Rate Uncertainty

A model leading to employment hysteresis due to sunk hiring‐ and firing‐costs is proposed. A potential mechanism based on a band of inaction that could account for a ‘weaker’ relationship between employment and its determinants is augmented by exchange rate uncertainty. As a result of option value effects the band of inaction is widened. Thus, the hysteresis effects are strongly amplified by exchange rate uncertainty (as numerical examples demonstrate). Non‐linearities in the employment‐relation are implied, i.e. ‘spurts’ in new employment or firing may occur after an initially weak response to a reversal of the exchange rate.