What version of Premiere Elements, what computer operating system?
What are the properties of the two videos involved - brand/model/settings of the camera that recorded the video?
What are you (manually) or the project (automatically) setting as the project preset to match the properties of those source videos?
What is the size of the project when this freezing and skipping is going on in the Timeline?
Please confirm if this is the situation that you face....
You place video (object on green background) on Video Track 2 and apply Videomerge effect to replace the green with transparency so that a video on Video 1 can be seen as background for the object instead of the original green.
Getting back to video properties, what is the difference, if any, in the video format of the video with object on green versus video being used as background?
Please consider, supply more information, and then we can decide what next based on the details in your reply.