The Rigidity Bias
Bank of Finland Discussion Paper No. 31/2003
34 Pages Posted: 19 Feb 2004
Date Written: November 12, 2003
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: Suggested Citation