Any YouTube link I play on VLC won't play on any definition lower than 360p, even when set to 240p. All other definitions (480, 720, 1080p) seem to be stable.
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I believe that the reason it doesn't work is that YouTube simply doesn't offer such low resolutions: the existence of the configuration setting doesn't guarantee that VLC will be able to select that resolution, however in your case it does the next best thing and plays the lowest resolution available, 360p.
To be more accurate, YouTube offers only a reduced range of available resolutions and codecs for fully muxed, ready-to-play, audio+video progressive-download media files - which is what the YouTube playback feature uses. (In the same way, 1080p is not available.) It offers a wider choice of formats for audio-only and video-only streams to pick from and combine, however I expect that audio/video combining from multiple streams using an input slave, would be less reliable than the current behavior, and this is one reason why it is not currently supported.
Feel free to come back to me with specific YouTube video URLs if you think there is a more particular issue.