Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium

Abstract

We compare three pricing mechanisms for monetary economies: bargaining (search equilibrium); price taking (competitive equilibrium); and price posting (competitive search equilibrium). We do this in a framework that, in addition to considering different mechanisms, extends existing work on the microfoundations of money by allowing a general matching technology and endogenous entry. We study how the nature of equilibrium and effects of policy depend on the mechanism. Under bargaining, trades and entry are both inefficient, and inflation implies a first-order welfare loss. Under price taking, the Friedman rule solves the first inefficiency but not the second, and inflation can actually improve welfare. Under posting, the Friedman rule implies first best, and inflation reduces welfare but the effect is second order. * This paper has benefited from repeated discussions with Ricardo Lagos and Matthew Ryan. We also thank participants at the SED conference in Paris (2003) for useful comments.

On the optimality of the Friedman rule in a New Monetarist model

“…In this paper, the suboptimality of the rule is caused by the externalities in the search process and the nonexistence of a competitive market for search intensity. 3 Our results reinforce those of Rocheteau and Wright (2005). In Rocheteau and Wright (2005), the sellers are subject to free-entry conditions.…”

“…Efficiency in search intensity requires the marginal cost of search effort to be equal to its marginal benefit, that is, the marginal increase of matching probability multiplied by the total surplus. When buyers' search effort affects sellers' matching probability, the effort is 2 Our assumption of competitive pricing and endogenous search effort is close to that of Rocheteau and Wright (2005). As in Rocheteau and Wright (2005), the search effort represents the measure of agents who can trade in a competitive market, or equivalently, the effort decides the probability of success in entering the decentralized market.…”

“…When buyers' search effort affects sellers' matching probability, the effort is 2 Our assumption of competitive pricing and endogenous search effort is close to that of Rocheteau and Wright (2005). As in Rocheteau and Wright (2005), the search effort represents the measure of agents who can trade in a competitive market, or equivalently, the effort decides the probability of success in entering the decentralized market. inefficient because the buyers are concerned only about their own surplus, which is less than the total surplus.…”

“…In Rocheteau and Wright (2005), the sellers are subject to free-entry conditions. Rocheteau and Wright (2005) show that the entry level may be inefficiently high under the Friedman rule and a deviation from the rule may improve welfare by reducing output. Table 1 compares our study with the existing literature.…”

Pairwise trade, asset prices, and monetary policy

“…The parameter y k can then be interpreted as a measure of the liquidity of the asset k, that is, the extent to which it can be used to finance 21 In search monetary models, the Friedman rule can be suboptimal because of search externalities (Rocheteau and Wright, 2005) or distortionary taxes (Aruoba and Chugh, 2010). Also, if the coercive power of the government is limited, then the Friedman rule might not be incentive-feasible (Hu et al, 2009;Andolfatto, 2010).…”