The combination of a fixed exchange rate and downward nominal wage rigidity creates a real rigidity. In turn, this real rigidity makes the economy prone to involuntary unemployment during external crises. This paper presents a graphical analysis of alternative policy strategies aimed
at mitigating this source of inefficiency. First- and second-best monetary and fiscal solutions are analyzed. Second-best solutions are prudential, whereas first-best solutions are not.
The American Economic Review is a general-interest economics journal. The journal is published quarterly and contains articles on a broad range of topics. Established in 1911, the AER is among the nation's oldest and most respected scholarly journals in the economics profession.