Price Flexibility as a Two‐dimensional Concept and the Volatility of Output

The stabilizing effect of increased price flexibility has been challenged in a series of articles. We show that it is important to distinguish between two different dimensions of flexibility. An increase in the responsiveness of the price level with respect to excess demand may both stabilize and destabilize the economy depending on whether the price level reacts with a lag or whether prices adjust immediately. Hence, the degree of price rigidity in the sense of a delayed price reaction turns out to be of crucial importance for the consequences of an increase in the responsiveness of the price level.