Cost and Price Movements in Business Cycle Theories and Experience: Causes and Effects of OBserved Changes (SEE ALSO WP3131-Send out together)

This paper is a sequel to Working Paper No. 3131, "Hypotheses of Sticky Wages and Prices". My first objective is to re-examine the historical record of prices and wages. What changes in their behavior are indicated by the data and how can they be explained? Next, the models that imply that price flexibility may be destabilizing are identified and assessed. This requires in particular an analysis of the role of changes in interest rates and price expectations. Money wages and prices in general had a predominantly pro cyclical pattern of movement before World War II, at least during the major fluctuations, but no declines in the more recent business contractions. Real wages never conformed closely to business cycles but most of their weak reactions were procyclical. Depending on the underlying condition and sources of the shifts in the economy, the departures from flexibility mayor may not be destabilizing. The main contrast, though, is between the stabilizing potential of flexible relative prices and the destabilizing potential of major general price movements. Major deflations of the past had strong and adverse expectational and distributional effects. So had the recent inflation as it accelerated and grew increasingly volatile. But moderate fluctuations in the price level or the rate of inflation are not necessarily detrimental to the growth in real economic activity.