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Price Flexibility and Output Stability: An Old Keynesian View

The central macroeconomic issue is the same as ever. How reliable are automatic market adjustments in maintaining full employment equilibrium in the face of aggregate demand shocks? Many modern theorists assume that nominal prices, including wages, jump instantaneously to keep supply and demand equal in all markets. No excess supply, no involuntary unemployment, can ever arise. However, since actual price adjustments take real time, greater flexibility can be destabilizing. "Real balance" effects are overrated, and the demand effects of nominal price changes are perverse. Activist macro policies are necessary, as Keynes argued, even though nominal prices are far from rigid.

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File URL: http://cowles.econ.yale.edu/P/cd/d09b/d0994-r.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 994R.

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Length: 36 pages
Date of creation: 1991
Date of revision: Sep 1991
Publication status: Published in Journal of Economic Perspectives (Winter 1993), 7(1): 45-65
Handle: RePEc:cwl:cwldpp:994r
Note: CFP 834.
Contact details of provider: Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
Phone: (203) 432-3702
Fax: (203) 432-6167
Web page: http://cowles.econ.yale.edu/

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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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  1. James Tobin, 1955. "A Dynamic Aggregative Model," Journal of Political Economy, University of Chicago Press, vol. 63, pages 103.
  2. Plosser, C.I., 1989. "Understanding Real Business Cycles," Papers 89-03, Rochester, Business - General.
  3. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
  4. Chadha, Binky, 1989. "Is Increased Price Inflexibility Stabilizing?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 21(4), pages 481-97, November.
  5. Cooper, Russell & John, Andrew, 1988. "Coordinating Coordination Failures in Keynesian Models," The Quarterly Journal of Economics, MIT Press, vol. 103(3), pages 441-63, August.
  6. Dudley Dillard, 1988. "The Barter Illusion in Classical and Neoclassical Economics," Eastern Economic Journal, Eastern Economic Association, vol. 14(4), pages 299-318, Oct-Dec.
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