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The rigidity bias

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  • Risto Herrala

    (Bank of Finland)

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://128.118.178.162/eps/fin/papers/0404/0404019.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0404019.

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Date of creation: 27 Apr 2004
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Handle: RePEc:wpa:wuwpfi:0404019

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Web page: http://128.118.178.162

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Keywords: liquidity; central banking; monetary system;

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  1. Bengt Holmstrom & Jean Tirole, 1998. "LAPM: A Liquidity-based Asset Pricing Model," NBER Working Papers 6673, National Bureau of Economic Research, Inc.
  2. Xavier Freixas & Bruno Parigi, 1996. "Contagion and efficiency in gross and net interbank payment systems," Economics Working Papers 176, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 1996.
  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. Franklin Allen & Douglas Gale, 1999. "Financial Contagion," Levine's Working Paper Archive 2092, David K. Levine.
  5. 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.
  6. 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.
  7. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Ricardo J. Caballero & Arvind Krishnamurthy, 2001. "International Liquidity Illusion: On the Risks of Sterilization," NBER Working Papers 8141, National Bureau of Economic Research, Inc.
  9. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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