The Rigidity Bias

Bank of Finland Discussion Paper No. 31/2003

34 Pages Posted: 19 Feb 2004

See all articles by Risto Herrala

Risto Herrala

European Central Bank (ECB) - Directorate General International and European Relations

Date Written: November 12, 2003

Abstract

We study the basic economic problem of choice between long-term and short-term commitments under a general characterization of uncertainty (aggregate uncertainty). When contingencies are contractible, a perfect market of Arrow-Debreau contingent claims implements the social optimum. When contingencies are not contractible, long-term commitments receive too much weight in individual portfolios. The economy as a whole is too rigid during periods of high aggregate shocks. The model links a rigidity bias with the operation of the price mechanism and the monetary system.

Keywords: liquidity, central banking, monetary system

JEL Classification: G0, E0

Suggested Citation

Herrala, Risto, The Rigidity Bias (November 12, 2003). Bank of Finland Discussion Paper No. 31/2003, Available at SSRN: https://ssrn.com/abstract=501766 or http://dx.doi.org/10.2139/ssrn.501766

Risto Herrala (Contact Author)

European Central Bank (ECB) - Directorate General International and European Relations ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

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