rssw - The Search-Theoretic Approach to Monetary Economics:...

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The Search-Theoretic Approach to Monetary Economics: A Primer ¤ Peter Rupert Martin Schindler Andrei Shevchenko Randall Wright March 27, 2000 Abstract This paperpresents a simple version of the basic models used in the search-theoretic approach to monetary economics. We discuss results on the existence of monetary equilibria, the potential for multiple equilibria, and welfare. We do this for models where prices are …xed, and also where prices are determined endogenously using bilateral bargaining theory. We also discuss the nature of the frictions necessary to construct a model with an essential role for money. We conclude the paper with a review of many extensions and applications in the related literature. ¤ All authors are a¢liated with the Federal Reserve Bank of Cleveland; the latter three are also a¢liated with the University of Pennsylvania. 1
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1 Introduction This paper presents some results in monetary theory derived using very sim- ple game-theoretic models of the exchange process. The underlying model is a variant of what is called search theory , a framework that has been used extensively in a wide variety of applications. This approach is well-suited to discussing the process of exchange, and the role that money may have in this process. In addition, the approach utilized here is explicitly strategic, in the following natural sense: when I decide whether or not to accept in trade a certain object other than one I desire for my own consumption – e.g., money – I need to formulate a conjecture regarding the probability that other agents will accept it from me in the future. This evidently ought to be modeled as a game. In search-theory, the type of game that will be considered is explicitly dynamic, and exchange takes place in real time. Also, the models allow us to focus precisely on various frictions in the exchange process that potentially give a role for money as part of an equilibrium arrangement, or an e¢cient arrangement. These frictions include the following: agents are not always in 2
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the same place at the same time; there is no way to enforce long-run commit- ments (unless they are dynamically incentive compatible); and that agents are anonymous in the sense that their histories are not public information. These types of frictions are crucial for a logically coherent theory of money, and the approach described here helps to make clear the role of each of these frictions. This approach is to be contrasted with trying to model the role of money in a competitive equilibrium (Walrasian) model – a di¢cult task that has met with, at best, mixed success in the past. 1 First, in a competitive equilibrium model, the exchange process is not explicity modeled. That is, agents start with an initial allocation A , and choose a …nal allocation B so as to maximize utility, subject to the latter not costing more than the former, but there is no discussion of how they get from point A to point B . Does some unmodeled agent (maybe the auctioneer) make the necessary trades with a “pick up and delivery service”? Or do the agents trade directly with each other? Do
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This essay was uploaded on 04/20/2008 for the course ECON 800 taught by Professor Krueger during the Spring '02 term at Stanford.

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rssw - The Search-Theoretic Approach to Monetary Economics:...

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