COMPENSATION FOR QUALITY DIFFERENCE IN A SEARCH MODEL OF MONEY*

We study an economy in which there is always double coincidence of wants, agents have perfect information about qualities of goods, and there are no transaction costs. The hold‐up problem arises because efforts invested in improving quality prior to search may not be compensated in the market. Situations in which barter fails to motivate quality improvement are identified. With money, however, the extra effort in quality improvement will be compensated when high‐quality good producers trade with agents holding both the low‐quality good and money. Injection of money can induce almost all agents to produce the high‐quality good.     

Bargains,Barter, and Money

We examine a search money model in which there is a symmetric coincidence of wants in all barter matches. However, when bargaining outcomes are asymmetric across matches, the barter economy is inefficient. Then a robust monetary equilibrium exists provided that money holders enjoy adequate bargaining terms. Fiat money may be welfare improving. In contrast to the literature, it is the asymmetry in bargains across matches rather than asymmetry in demands that generates these results. Journal of Economic Literature Classification Numbers: C78, E40.     

Liquidity, Quality, Production Cost, and Welfare in a Search Model of Money

This paper examines a search model of money with divisible commodities of high and low quality, while keeping the assumptions of indivisible money and unit-inventory constraint. With no direct barter and a higher fixed cost of producing high relative to low quality, an increase in the money stock encourages the production of high-quality output by trading off the larger trading opportunities against the significance of higher fixed cost. As long as the fixed-cost differential between high and low quality is sufficiently small relative to the utility gain from high-quality consumption, the quality improvement outweighs the negative effect of higher money stocks on aggregate production, and hence implies higher welfare.     

Can growth-enhanced monetary policy improve welfare when people seek social status?

This paper examines the growth and welfare effects from an increase in the rate of money supply in an Ak type growth model with a relative wealth-enhanced social status motive, production externalities, and liquidity constraints. When only consumption is constrained by liquidity, fast money supply can hasten output growth unless seigniorage revenue is wasted and production externalities do not exist. We find that even though money growth normally promotes economic growth, it does not improve welfare when capital stock is over-accumulated. In general, an optimal monetary policy minimizes seigniorage. Our results also conclude that the optimal monetary policy rarely follows the Friedman rule.     

Jack of All Trades or a Master of One? Specialization,Trade, and Money*

We consider a model of decentralized exchange where individuals choose the set of goods they produce. Specialization involves producing a smaller set of goods and doing it more proficiently. In doing so, agents reduce production costs, but also reduce the ease of trading their output. We derive the equilibrium degree of specialization and examine how it is affected by underlying fundamentals. Due to the existence of a hold‐up problem, individuals specialize too little relative to the social optimum. Introducing money leads to more specialization relative to barter and increases welfare.     

Discrete Choice Experiments in Developing Countries: Willingness to Pay Versus Willingness to Work

A concern when conducting stated preference valuation studies in rural developing or very low income contexts is the use of monetary willingness to pay (WTP) estimates. In circumstances where cash incomes are extremely low, a significant proportion of the population are not engaged in waged labour and the exchange of goods or services is augmented through barter or work exchange, the role of money is likely to be different from that within an urban developed setting. As such, ability to pay using money may be impaired and downwardly biased when compared with other mediums of exchange. In recognition of this several studies have used hypothetical labour contributions as payment vehicles and a common finding is that households are more often willing to contribute labour than they are money. In this paper we present the results of a split sample DCE using money and labour contributions as payment vehicles for improved drinking water quality in Kandal Province, Cambodia. We find little differences between the payment vehicles in terms of attribute non-attendance, marginal utilities of attributes or derived welfare values. We argue that this provides support for the use of WTP in rural developing areas where there are functioning labour markets.     

Barter, credit and welfare

This paper develops a model to investigate the welfare implications of barter in Russia and other transition economies during the 1990s. We argue that barter is a welfare‐improving phenomenon that acts as a defence mechanism against monetary instability. When firms react to tighter credit markets by switching to barter, the risk they face diminishes, allowing for a higher level of production.     

Search, money, and inflation under private information

I study monetary exchange and inflation when buyers have private information about their willingness to pay for certain goods. Introducing imperfect information in the Lagos-Wright [A unified framework for monetary theory and policy analysis, J. Polit. Economy 113(3) (2005) 463-484] economy shows that the existence of monetary equilibrium is a more robust feature of the environment. In general, my model has a monetary steady state in which only a proportion of the agents hold money. Agents who do not hold money cannot participate in trade in the decentralized market. The proportion of agents holding money is endogenous and depends (negatively) on the level of expected inflation. As in Lagos and Wright's model, in equilibrium there is a positive welfare cost of expected inflation, but the origins of this cost are very different.     

The workings of a commodity money system in an incomplete information macro model

This paper compares the properties of a token money system with that of a commodity money system in an uncertain environment. In an incomplete information world, relative prices are not known with certainty. However, a commodity money system provides some information because the nominal price of the monetary commodity is known. The benefits of this information-enhancing function may be offset, though by distortions in relative prices relative to their full information Walrasian equilibrium values. Because the two systems have vastly different structural parameters, we cannot unambiguously state which system is welfare superior.     

The Conceptual Flaw in the Microeconomic Foundations of Dynamic Stochastic General Equilibrium Models

First-generation dynamic stochastic general equilibrium (DSGE) models have been criticized for their lack of financial markets but, more perceptively, for their barter properties. This note explains why the second of these criticisms is fundamental. All DSGE models are built on frictionless, perfect barter, Walrasian microeconomic foundations. Introducing money and banks into such models converts them into a ‘friction’ contra the fundamental principle that monetary exchange is more efficient than barter. This insoluble difficulty with the microeconomic foundations of DSGE models arises because theorists ignore the Hahn problem that applies to all monetary models based on Walrasian general equilibrium (GE) microeconomic foundations. The Hahn problem reveals three things. First, a perfect barter GE solution always exists in any ‘monetary’ model erected on Walrasian GE microeconomic foundations. Second, inessential monetary features are easily attached to perfect barter microeconomic foundations but as easily removed, leaving the perfect barter solution intact. Third, attaching such inessential additions leads to logical error; the misuse of language that produces invalid conclusions. A second-generation DSGE model that is intended to increase understanding of financial crises is then examined to show that it suffers from the Hahn problem; it converts banking and financial markets into ‘frictions’, and words and economic concepts take on different meanings. That renders the new DSGE model impossible to interpret or use as a basis for advice on monetary policy.     

THE SUPERIORITY OF MONETARY OVER BARTER EXCHANGE: EXPERIMENTAL RESULTS AND POLICY IMPLICATIONS

William Stanley Jevons suggested that monetary exchange is socially superior to barter exchange because agents' optimization is simplified by the use of money. We experimentally study how subjects perform under monetary and barter exchange and find that a majority of subjects achieve a higher utility level in the monetized economy. The individual choices are statistically analyzed in order to track important elements of suboptimal decision making like the tendency to under‐ or over‐react to price signals. Our laboratory findings indicate that, at a minimum, government may have a role in promoting a common unit of account.     

Competitive search markets for durable goods

Summary. This paper considers a dynamic version of Akerlof's (1970) lemons problem where buyers and sellers must engage in search to find a trading partner. We show that if goods are durable, the market itself may provide a natural sorting mechanism. In equilibrium, high-quality goods sell at a higher price than low-quality goods but also circulate longer. This accords with the common wisdom that sellers who want to sell fast may have to accept a lower price. We then compare the equilibrium outcomes under private information with those under complete information. Surprisingly, we find that for a large range of parameter values the quilibrium outcomes under the two information regimes coincide, despite the fact that circulation time is used to achieve separation. Received: August 24, 2000; revised version: October 24, 2000     

Existence of a continuum of equilibria in a monetary random-matching model

In this paper, we study a monetary random-matching model where both goods and money are perfectly divisible, production is costly, and there is no exogenous upper bound on agents' money holdings, information on which is private to the agent. We show that there is a continuum of stationary equilibria where agents have either no money or a set amount, and buyers spend all their money. As in the previous studies, the equilibrium value function is step-like, which emerges as a self-fulfilling prophecy. The endogenous upper bound on agents' money holdings is the result of private information on agents' money holdings. Buyers post an offer that is accepted only by sellers without money, who set a higher value on money.     

Let the experts decide? Asymmetric information,abstention, and coordination in standing committees

We examine abstention when voters in standing committees are asymmetrically informed and there are multiple pure-strategy equilibria – swing voterʼs curse (SVC) equilibria where voters with low-quality information abstain and equilibria when all participants vote their information. When the asymmetry in information quality is large, we find that voting groups largely coordinate on the SVC equilibrium which is also Pareto optimal. However, we find that when the asymmetry in information quality is not large and the Pareto optimal equilibrium is for all to participate, significant numbers of voters with low-quality information abstain. Furthermore, we find that information asymmetry induces voters with low-quality information to coordinate on a non-equilibrium outcome. This suggests that coordination on “letting the experts” decide is a likely voting norm that sometimes validates SVC equilibrium predictions but other times does not.     

A model of trust in quality and North–South trade

Why do some countries produce higher quality goods than other countries? This paper suggests that one reason is self-perpetuating reputations, modelling the idea with a Klein–Leffler reputation model embedded in a general equilibrium model of trade. Reputation differences are particularly interesting because reputation is a form of “social capital”. Like product differentiation, it can explain why countries might trade even if their technologies and endowments are identical, why firms could profit from exports even if the foreign price is no higher than the domestic one, and why governments like to have “high-value” sectors. Ideally, a developing country would shift its own producers to a high-quality equilibrium; if that is not possible, the next best thing is to import experience goods and substitute to home production of goods for which reputation is not important.     

Bidding for money

We analyze monetary exchange in a model that allows for directed search and multilateral matches. We consider environments with divisible goods and indivisible money, and compare the results with those in models that use random matching and bilateral bargaining. Two different pricing mechanisms are used: ex ante price posting, and ex post bidding (auctions). Also, we consider settings both with and without lotteries. We find that the model generates very simple and intuitive equilibrium allocations that are similar to those with random matching and bargaining, but with different comparative static and welfare properties.     

Money and the gains from trade*

This article studies the role of money in environments where in each meeting there is a double coincidence of real wants. Traders who meet at random finance their purchases through current production, the sale of divisible money or both. It is shown that in the absence of valued money if traders have asymmetric tastes for each other's good, they produce and exchange socially inefficient quantities. With valued money, however, traders exchange efficient quantities if the asymmetry of tastes is not too large. It is shown that the gains from trade in the monetary economy are strictly greater than those in the corresponding barter economy, that the Friedman rule holds, and that the allocation of resources in the monetary economy converges to the allocation in the barter economy as the growth rate of the money supply is increased.     

Money,price dispersion and welfare

Summary. We introduce heterogeneous preferences into a tractable model of monetary search to generate price dispersion, and then examine the effects of money growth on price dispersion and welfare. With buyers search intensity fixed, we find that money growth increases the range of (real) prices and lowers welfare as agents shift more of their consumption to less desirable goods. When buyers search intensity is endogenous, multiple equilibria are possible. In the equilibrium with the highest welfare level, money growth reduces welfare and increases the range of prices, while having ambiguous effects on search intensity. However, there can be a welfare-inferior equilibrium in which an increase in money growth increases search intensity, increases welfare, and reduces the range of prices.Received: 25 July 2003, Revised: 12 December 2003JEL Classification Numbers: E31, D60.B. Peterson, S. Shi: We thank Gabriele Camera, Aleksander Berentsen and an anonymous referee for useful suggestions. We have also received valuable comments from the participants of the workshop at Michigan State, the Purdue Conference on Monetary Theory (2003) and the Midwest Macro Meeting (Chicago, 2003). Shi gratefully acknowledges financial support from the Bank of Canada Fellowship and the Social Sciences and Humanities Research Council of Canada. The opinion expressed here is the authors own and does not reflect the view of the Bank of Canada.Correspondence to: S. Shi     

Are labels effective against child labor?

In this paper, we investigate the impact of introducing a label certifying the absence of child labor in the export production of the South. When most eligible producers in the South can obtain the label, its impact is considerably reduced by a displacement effect whereby adult workers replace children in the export sector while children replace adults in the domestic sector. The label is then unable to create a price differential in the South between goods produced under the label and those produced without it.When only a small fraction of eligible producers have access to the label, the South exports both labeled and unlabeled goods to the North. In this case, labeled producers generally gain while those without a label generally loose from the introduction of the label. Ex ante welfare may fall in the South if the probability of getting a label when one qualifies is small. The impact on child labor is in general ambiguous.     

EQUILIBRIUM GROWTH IN A MONETARY ECONOMY WITH TRANSACTIONS COSTS*

The paper describes a dynamic general equilibrium monetary economy with technological primitives that are consistent with the possibility of asymptotic equilibrium growth. The paper focuses on the relationship between equilibrium financing constraints on investment goods, transaction costs and economic growth. A generalized growth condition is derived that involves both monetary growth rates and transaction costs. The condition is used to show that (i) although inflation taxes can potentially exert a negative influence on long-run economic growth, these growth effects cannot in general be arbitrarily large; and (ii) for some monetary growth rates, money is superneutral in contrast to the models of Stockman and Abel. Numerical work indicates that although the welfare and growth effects of decreasing nominal interest rates from a benchmark are large, the costs associated with raising nominal interest rates from benchmark are not.