NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Is Increased Price Flexibility Stabilizing? Redux

Saroj Bhattarai, Gauti Eggertsson, Raphael Schoenle

NBER Working Paper No. 19886
Issued in February 2014
NBER Program(s):ME

We study the implications of increased price flexibility on output volatility. In a simple DSGE model, we show analytically that more flexible prices always amplify output volatility for supply shocks and also amplify output volatility for demand shocks if monetary policy does not respond strongly to inflation. More flexible prices often reduce welfare, even under optimal monetary policy if full efficiency cannot be attained. We estimate a medium-scale DSGE model using post-WWII U.S. data. In a counterfactual experiment we find that if prices and wages are fully flexible, the standard deviation of annualized output growth more than doubles.

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Document Object Identifier (DOI): 10.3386/w19886

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