Is Increased Price Flexibility Stabilizing?
J. Bradford DeLong
University of California, Berkeley; Federal Reserve Bank of San Francisco; National Bureau of Economic Research (NBER)
Lawrence H. Summers
Harvard University; National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)
NBER Working Paper No. w1686
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.
Number of Pages in PDF File: 32
Date posted: June 8, 2004