Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/186742 
Year of Publication: 
1991
Series/Report no.: 
Working Paper No. 52
Publisher: 
Levy Economics Institute of Bard College, Annandale-on-Hudson, NY
Abstract: 
In conventional macroeconomic thought, price flexibility stabilizes thc economy. The more quickly prices fall (or inflation decreases) in a demand-induced recession, the faster output returns to its full-employment level. An alternative tradition, however, suggests that price flexibility can be destabilizing. If a recession reduces expectations of Jitlzre prices, this can raise current real interest rates and dampen aggregate demand. In addition, as actual current prices fall in a recession, real debt burdens rise which can reduce aggregate demand due to financial distress or the response of capital markets. This paper presents simulations from a dynamic macroeconomic model designed to examine the empirical effects of price flexibility. Our results show that, for credible specifications and parameter values7 the destabilizing effects of greater price flexibility can be larger than the conventional stabilizing channels. Therefore, it is possible that greater price flexibility magnifies the severity of economic contractions initiated by negative demand shocks.
Document Type: 
Working Paper

Files in This Item:
File
Size
1.86 MB





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.