No abstract

We study the emergence of norms of cooperation in experimental economies populated by strangers interacting indefinitely. Can these economies achieve full efficiency even without formal enforcement institutions? Which institutions for monitoring and enforcement facilitate cooperation? Finally, what classes of strategies do subjects employ? We find that, first, cooperation can be sustained even in anonymous settings; second, some type of monitoring and punishment institutions significantly promote cooperation; and, third, subjects mostly employ strategies that are selective in punishment. (JEL C71, C73, D12, Z13)

, and seminar participants at the Summer Econometric Society, the Society for Economic Dynamics, and Penn State. We especially wish to thank Randy Wright and two anonymous referees for helpful comments on an earlier version of this paper.

Under what conditions can cooperation be sustained in a network of strangers? Here we study the role of institutions and uncover a new behavioral foundation for the use of monetary systems. In an experiment, anonymous subjects could cooperate or defect in bilateral random encounters. This sequence of encounters was indefinite; hence multiple equilibria were possible, including full intertemporal cooperation supported by a social norm based on community punishment of defectors. We report that such social norm did not emerge. Instead, the availability of intrinsically worthless tokens favored the coordination on intertemporal cooperation in ways that networks of strangers were unable to achieve through social norms.

We study infinite-horizon monetary economies characterized by trading frictions that originate from random pairwise meetings, and commitment and enforcement limitations. We prove that introducing occasional trade in "centralized markets" opens the door to an informal enforcement scheme that sustains a non-monetary efficient allocation. All is required is that trading partners' be patient and their actions be observable. We then present a matching environment in which trade may occur in large markets and yet agents' trading paths cross at most once. This allows the construction of models in which infinitely-lived agents trade in competitive markets where money plays an essential role.

What makes money essential for the functioning of modern society? Through an experiment, we present evidence for the existence of a relevant behavioral dimension in addition to the standard theoretical arguments. Subjects faced repeated opportunities to help an anonymous counterpart who changed over time. Cooperation required trusting that help given to a stranger today would be returned by a stranger in the future. Cooperation levels declined when going from small to large groups of strangers, even if monitoring and payoffs from cooperation were invariant to group size. We then introduced intrinsically worthless tokens. Tokens endogenously became money: subjects took to reward help with a token and to demand a token in exchange for help. Subjects trusted that strangers would return help for a token. Cooperation levels remained stable as the groups grew larger. In all conditions, full cooperation was possible through a social norm of decentralized enforcement, without using tokens. This turned out to be especially demanding in large groups. Lack of trust among strangers thus made money behaviorally essential. To explain these results, we developed an evolutionary model. When behavior in society is heterogeneous, cooperation collapses without tokens. In contrast, the use of tokens makes cooperation evolutionarily stable. Here, we study two issues: (i) Do individuals develop cooperative norms in large groups as easily as they do in small groups? (ii) How do monetary systems affect behavior in a society of strangers?Field evidence on the first issue is ambiguous, as many factors covary with group size. Typically, payoffs to cooperation are lower in small groups-as the result of a reduced scope for specialization-but members can monitor each other better than in large groups and can communicate more easily.

We construct a monetary economy with heterogeneity in discounting and consumption risk. Agents can insure against this risk with money and nominal government bonds, but all trades must be monetary. We demonstrate that a deflationary policy à la Friedman cannot sustain the constrainedefficient allocation as no-arbitrage imposes too stringent a bound on the return money can pay. The constrained-efficient allocation can be sustained when bonds have positive yields and, under certain conditions, only if they are illiquid. Illiquidity, meaning that bonds cannot be transformed into consumption as easily as cash, is necessary to eliminate arbitrage opportunities due to disparities in shadow interest rates.

Recent monetary models with explicit microfoundations are made tractable by assuming that agents have access to centralized markets after one round of decentralized trade. Given quasi-linear preferences, this makes the distribution of money degenerate -which keeps the models simple but precludes discussion of distributional e!ects of monetary policy. We generalize these models by assuming two rounds of trade before agents can readjust their money holdings to study a range of new distributional e!ects analytically. We show that unexpected, symmetric lump-sum money injections may increase short-run output and welfare, while asymmetric injections may increase long-run output and welfare.