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.     

Indivisibilities, Lotteries, and Monetary Exchange

We introduce lotteries (randomized trading) into search-theoretic models of money. In a model with indivisible goods and fiat money, we show goods trade with probability 1 and money trades with probability τ, where τ<1 iff buyers have sufficient bargaining power. With divisible goods, a nonrandom quantity q trades with probability 1 and, again, money trades with probability τ where τ<1 iff buyers have sufficient bargaining power. Moreover, q never exceeds the efficient quantity (not true without lotteries). We consider several extensions designed to get commodities as well as money to trade with probability less than 1, and to illuminate the efficiency role of lotteries. Journal of Economic Literature Classification Numbers: E40, D83.     

BARTER'S ROLE IN THE MONEY–INCOME RELATIONSHIP

Abstract.  This paper deals with a reassessment of the money–income relation and predictability of changes in GDP with innovations in money in the presence of barter. Organized barter as a method of transaction, through barter exchanges, has been growing rapidly in the US economy. With the introduction of computers and the use of a credit system which allows non-simultaneous transactions, barter exchanges have found new opportunities to offer an alternative to monetary transactions. Analysis of data from the 1974–96 period provides some evidence suggesting that inclusion of barter in the output function improves the marginal predictability of money.     

Money and specialization

Summary.  This paper examines the relationship between specialization and the use of money in two versions of the search-theoretic monetary model. The first version establishes a surprising result that specialization is more likely to occur in a barter economy than in a monetary economy. The result is reversed in the second version where a different specification of preferences is adopted to limit the scope of barter. This contrast between the results provides a concrete illustration of the general argument that money encourages specialization only when it enlarges the extent of the market. Received: January 31, 1995; revised version August 12, 1996     

Money,barter, and consumption interdependence

By introducing a degree of consumption interdependence into a search model, we show that people may switch from using money to bartering during hyperinflation, but barter activities, however, could still be popular even though the inflation rate is low.     

Money and Information

This paper investigates the role of money in markets in which producers have private information about the quality of the goods they supply. When the fraction of high-quality producers in the economy is given, money promotes the production of high-quality goods, which improves the quality mix and welfare unambiguously. When this fraction is endogenous, however, we find that money can decrease welfare relative to the barter equilibrium. The origin of this inefficiency is that money provides consumption insurance to low-quality producers, which can result in a higher fraction of low-quality producers in the monetary equilibrium. Finally, we find that most often agents acquire more costly information in the monetary equilibrium than in the barter equilibrium. Consequently, money is welfare-enhancing because it promotes useful production and exchange, but not because it saves information costs.     

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 HOLDINGS,INFLATION, AND WELFARE IN A COMPETITIVE MARKET*

This article examines an environment where money is essential and agents exchange in perfectly competitive, Walrasian markets. Agents consume and produce a homogeneous good, but hold money to purchase consumption in the event of a relatively low productivity shock. A Walrasian market delivers a nondegenerate distribution of money holdings across agents and avoids some of the computational difficulties associated with the market assumption of bilateral bargaining common to search‐theoretic environments. The model is calibrated to long‐run U.S. velocity, and the welfare costs of inflation are assessed for variable buyer–seller ratios and persistent states of buying and selling.     

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.     

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.     

Matching markets with price bargaining

The extant microeconomic literature on matching markets assumes ordinal preferences for matches, while bargaining within matches is mostly excluded. Central for this paper, however, is bargaining over joint profits from potential matches. We investigate, both theoretically and experimentally, a seemingly simple allocation task in a 2×2 market with repeated negotiations. When inefficiency is possible, about 1/3 of the complete matches are inefficient and, overall, more than 3/4 of the experimental allocations are unstable. These results strongly contradict existing bargaining theories requiring efficient matches. Even with regard to efficient matches, the tested theories perform poorly. Standard bargaining and behavioral concepts, such as Selten’s (1972) Equal Division Core, are outperformed by the simplistic ε-Equal Split, i.e., an equal split of the joint profit plus/minus ε.     

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.     

Bargaining with random implementation: An experimental study

We use a laboratory experiment to study bargaining with random implementation. We modify the standard Nash demand game so that incompatible demands do not necessarily lead to the disagreement outcome. Rather, with exogenous probability q, one bargainer receives his/her demand, with the other getting the remainder. We use an asymmetric bargaining set (favouring one bargainer) and disagreement payoffs of zero, and we vary q over several values.Our results mostly support game theoryʼs directional predictions. As with conventional arbitration, we observe a strong chilling effect on bargaining for q near one: extreme demands and low agreement rates. Increasing q reinforces the gameʼs built-in asymmetry – giving the favoured player an increasingly large share of payoffs – but also raising efficiency. These effects are non-uniform: over sizable ranges, increases in q have minimal effect, but for some q, small additional increases lead to sharp changes in results.     

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.     

Wage bargaining and induced technical change in a linear economy: Model and application to the US (1963–2003)

In a simple one-sector, two-class, fixed-proportions economy operating at full capacity, wages are set through generalized axiomatic bargaining à la Nash (1950). As for choice of technology, firms choose the direction of factor-augmenting innovations to maximize the rate of unit cost reduction (Kennedy, 1964, Funk, 2002). The aggregate environment resulting by self-interested decisions made by economic agents is described by a two-dimensional dynamical system in the employment rate and output/capital ratio. The economy converges cyclically to a long-run equilibrium involving a Harrod-neutral profile of technical change, a constant rate of employment of labor, and constant input shares. The type of oscillations predicted by the model matches qualitatively the available data on the United States (1963–2003). Institutional change, as captured by variations in workers’ bargaining power, has a positive effect on the rate of output growth but a negative effect on employment.     

Search, Bargaining, Money, and Prices Under Private Information

This paper presents a model of money and search where bargaining determines prices and the quality of goods is private information. It studies how a lemons problem affects the purchasing power of money. There are multiple, Pareto-ranked equilibria. The superior equilibrium, where no lemons are produced, exists even if information about quality is relatively scarce. In other equilibria, there is price dispersion, and uninformed buyers pay higher prices than informed buyers for all goods. Taxing money balances (a proxy for inflation) makes buyers less selective, thus reducing the average quality of supply and the premium paid for known quality.     

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.     

F.A. von Hayeks theorie der geldwirtschaft in neuerer sicht

This essay tries to reconstruct the analytical framework of F.A. von Hayek's theory of a monetary economy. In Hayek's analysis the concept of neutral money only serves to determine a point of reference which is derived from a model of ideal barter. According to Hayek's programme monetary theory should develope by giving up the implicite analogy to a barter economy and by analysing instead a monetary economy as a phenomenon of its own.The approach of the new classical macroeconomics is critically examined from this point of view. It is shown that the coordination of plans and expectations implied by this approach is incompatible with decentralized monetary transactions. This type of model therefore does not stand up to the demands formulated in Hayek's programme.     

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.     

The Role of Non-monetary Trade in Russian Transition

The appearance of significant non-monetary trade in the Russian transition of 1992-98 has been differently interpreted by analysts and observers. Some have seen barter as a symbol of passive resistance to reforms while others have blamed reformist policies for its development. We argue that non-monetary trade is best understood as a natural response of companies to market imperfections remaining from Soviet times. We provide an overview of market institutions that existed at the onset of the transition and conclude that market infrastructure was under-developed (especially trade and finance-related institutions). This fact became obvious after the liberalisation of trade in 1992. When the Central Bank of Russia stopped issuing direct credit to enterprises, newly established commercial banks were unable to fill the gap. Firms had to develop alternative means of financing trade and non-monetary trade was one of them. In our opinion barter, while an inefficient mode of trade, also played a positive role in the transition. Its high transaction costs offered ample opportunities to earn profits from trade and financial intermediation. The latter mushroomed as a result and at the time of the 1998 default the Russian economy had sufficiently developed trade, financial and legal systems to afford a switch from barter to money trade.