Is Increased Price Flexibility Stabilizing? Redux

Saroj Bhattara, Gauti Eggertsson and Raphael Schoenle
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Saroj Bhattara: Penn State University

No 41, Working Papers from Brandeis University, Department of Economics and International Business School

Abstract: We study the implications of increased price flexibility on aggregate output volatility in a dynamic stochastic general equilibrium (DSGE) model. First, using a simplified version of the model, we show analytically that the results depend on the shocks driving the economy and the systematic response of monetary policy to inflation: More flexible prices amplify the effect of demand shocks on output if interest rates do not respond strongly to inflation, while higher flexibility amplifies the effect of supply shocks on output if interest rates are very responsive to inflation. Next, we estimate a medium-scale DSGE model using post-WWII U.S. data and Bayesian methods and, conditional on the estimates of structural parameters and shocks, ask: Would the U.S. economy have been more or less stable had prices been more flexible than historically? Our main finding is that increased price flexibility would have been destabilizing for output and employment.

Keywords: Increased price exibility; Aggregate volatility; Systematic monetary policy; DSGE model; Bayesian estimation (search for similar items in EconPapers)
JEL-codes: D58 E31 E32 E52 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2012-01
New Economics Papers: this item is included in nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP41.pdf First version, 2012 (application/pdf)

Related works:
Journal Article: Is increased price flexibility stabilizing? Redux (2018)
Working Paper: Is Increased Price Flexibility Stabilizing? Redux (2014)
Working Paper: Is increased price flexibility stabilizing? Redux (2012)
Working Paper: Is Increased Price Flexibility Stabilizing? Redux (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:brd:wpaper:41

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