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The rigidity bias

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  • Herrala, Risto

    ()
    (Bank of Finland Research)

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.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0331.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 31/2003.

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Length: 34 pages
Date of creation: 12 Nov 2003
Date of revision:
Handle: RePEc:hhs:bofrdp:2003_031

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Keywords: liquidity; central banking; monetary system;

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  1. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Franklin Allen & Douglas Gale, 2000. "Financial Contagion," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 1-33, February.
  3. Douglas W. Diamond & Raghuram G. Rajan, 1998. "Liquidity risk, liquidity creation and financial fragility: a theory of banking," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  4. Michael D. Bordo, 1990. "The lender of last resort : alternative views and historical experience," Economic Review, Federal Reserve Bank of Richmond, issue Jan, pages 18-29.
  5. Ricardo J. Caballero & Arvind Krishnamurthy, 2001. "International Liquidity Illusion: On the Risks of Sterilization," NBER Working Papers 8141, National Bureau of Economic Research, Inc.
  6. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  7. Xavier Freixas & Bruno Parigi, 1998. "Contagion and efficiency in gross and net interbank payment systems," Proceedings 592, Federal Reserve Bank of Chicago.
  8. Bengt Holmstrom & Jean Tirole, 1998. "LAPM: A Liquidity Based Asset Pricing Model," Working papers 98-8, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
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