The Paradox of Price Flexibility in an Open Economy

Daeha Cho, Kwang Hwan and Sukjoon Kim
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Kwang Hwan: Yonsei University
Sukjoon Kim: New York University

Review of Economic Dynamics, 2023, vol. 51, 370-392

Abstract: Empirical evidence suggests that the degree of price stickiness is not uniform around the world. Heterogeneous price stickiness introduces a new propagation mechanism of global demand shocks that lead to a liquidity trap for all countries, which we call the open-economy paradox of flexibility. We show that the severity of the paradox increases with the degree of trade and capital market openness, when home and foreign goods are Edgeworth substitutes and when the more affected home country runs a trade deficit. This implies that highly open trade and financial linkages are not desirable in terms of world welfare. We show that the inefficiencies generated by heterogeneous price stickiness can be reduced through two types of international policy coordination: i) an arrangement in which the country with relatively sticky prices raises the interest rates or ii) a monetary union. (Copyright: Elsevier)

Keywords: Zero lower bound; Nominal rigidities; Optimal monetary policy; Monetary union (search for similar items in EconPapers)
JEL-codes: E32 E58 E61 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1016/j.red.2023.02.002

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