The asymmetric stabilizing effects of price flexibility: historical evidence and implications

The evidence of business cycles across a sample of industrial countries ind icates asymmetry in the output and price adjustments to aggregate demand sh ocks in the pre- and post-war periods. Upward price flexibility is signific ant in moderating output fluctuations across countries in the pre- and post -war periods. Nonetheless, the effect of upward price flexibility in accele rating trend price inflation is more evident across countries in the post-w ar period compared to the pre-war period. The combined evidence is consiste nt with a steeper supply curve in the face of expansionary demand shocks th at increases the stabilizing effect of upward price flexibility. In contras t, a flatter supply curve in the face of negative demand shocks has counter ed the stabilizing function of downward price flexibility, which appears in significant across countries in the pre- and post-war periods. In addition, a slower demand response to price change during recessions has further rei nforced the contractionary effect on output despite a large reduction in pr ice inflation across countries in the pre-war period. Apparent differences in the implications of upward and downward price flexibility point to the i mportance of policy intervention to moderate output contraction during rece ssions and price inflation during expansions.