MEASURING THE SPEED OF THE INVISIBLE HAND - THE MACROECONOMIC COSTS OF PRICE RIGIDITY

Price rigidity measured by the market inertia criterion appears to be a general characteristic of Japanese and European economics in 1974-19 92. The macroeconomic costs of this lack of flexibility are both a wel fare loss due to a suboptimal allocation that results in lower product ivity and a further reduction of the effectiveness of fiscal policy. T his is illustrated with an applied general equilibrium model for a sma ll open economy that has been calibrated for the Dutch economy. We use the hysteresis concept to investigate the efficiency of the goods mar kets. In doing so, we apply the market inertia criterion, which measur es the extent of market flexibility. According to this criterion, pric e flexibility appears to have been rather low in 1974-1992, especially in the European and Japanese economies. The macroeconomic costs of th is lack of flexibility am a decline in income and production due to su boptimal allocation resulting in lower productivity, and a reduction i n the effectiveness of fiscal policy. This is illustrated by means of an applied general equilibrium model for a small open economy.