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.