Is Increased Price Flexibility Stabilizing?
32 Pages Posted: 8 Jun 2004 Last revised: 12 Aug 2010
Date Written: August 1985
This paper uses Taylor's model of overlapping contracts to show that increased wage and price flexibility can easily be destabilizing. This result arises because of the Mundell effect. While lower prices increase output, the expectation of falling prices decreases output. Simulations based on realistic parameter values suggest that increases in price flexibility might bell increase the cyclical variability of output in the United States.
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