Toward a Theory of Rigidities

16 Pages Posted: 8 Aug 2007 Last revised: 14 Jul 2010

See all articles by Bruce C. N. Greenwald

Bruce C. N. Greenwald

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Joseph E. Stiglitz

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Date Written: April 1989

Abstract

This paper presents a theory of rigidity, or more properly inertia, in the responses of economic variables to changing environments. The theory rests on three fundamental assumptions: (1) that firms are risk averse, (2) that firms are uncertain of the impacts of changing decision variables and (3) that this uncertainty increases with the size of deviations in decision variables from appropriately defined past level. Under these circumstances an optimal portfolio of incremental decision variable adjustments exists which (a) takes variance minimizing adoptions to environmental change as a point of departure and then (b) is weighted in favor of changes in variables whose effects are less uncertain. In considering price and quantity adjustments, this implies that price and wage adjustments should largely incorporate expected inflation and, from that point, should be small relative to quantity adjustments, since in most situations the uncertainties associated with the consequences of quantity adjustment should be smaller than those associated with price adjustments.

Suggested Citation

Greenwald, Bruce and Stiglitz, Joseph E., Toward a Theory of Rigidities (April 1989). NBER Working Paper No. w2938. Available at SSRN: https://ssrn.com/abstract=461377

Bruce Greenwald (Contact Author)

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Joseph E. Stiglitz

Columbia Business School - Finance and Economics ( email )

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