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Is Increased Price Flexibility Stabilizing? Redux

Listed author(s):
  • Saroj Bhattarai
  • Gauti Eggertsson
  • Raphael Schoenle

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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File URL: http://www.nber.org/papers/w19886.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19886.

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Date of creation: Feb 2014
Handle: RePEc:nbr:nberwo:19886
Note: ME
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  1. Peter J. Klenow & Oleksiy Kryvtsov, 2008. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," The Quarterly Journal of Economics, Oxford University Press, vol. 123(3), pages 863-904.
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  3. De Long, James Bradford & Summers, Lawrence H, 1986. "Is Increased Price Flexibility Stabilizing?," American Economic Review, American Economic Association, vol. 76(5), pages 1031-1044, December.
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  19. repec:hrv:faseco:32116841 is not listed on IDEAS
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