Affordable Access

Is Price Flexibility De-Stabilizing? A Reconsideration

Publication Date
  • E52 - Monetary Policy
  • F41 - Open Economy Macroeconomics
  • Economics


Using a New Neoclassical Synthesis model of monetary policy for a small open economy, this paper explores the impact of an increased degree of price flexibility on output volatility. Previous analysis of this question – based on the earlier generation of descriptive macro systems with model-consistent expectations – offered mixed conclusions, especially in an open economy context. We update that literature by reconsidering the issue within models that involve optimization-based behavioural equations. We find clear support for Keynes’ concern that a higher degree of price flexibility raises output volatility – but only under flexible exchange rates. We discuss the implications of our findings for current macro policy discussions in both European and other economies.

There are no comments yet on this publication. Be the first to share your thoughts.