Money and Barter under Private Information

This paper examines the role of money when private information about the quality of the goods is present. In the private information environment, barter exchange for high-quality goods is rare since people have incentive to produce low-quality goods and attempt to cheat uninformed trading partners. This environment gives money a role in mitigating informational frictions. I consider two environments, one where traders can signal their quality of goods and one where they cannot, and two types of informational problems -- adverse selection and moral hazard -- in a search-theoretic framework. Both environments support the notion that money reduces the adverse selection problem and increases welfare. However, with moral hazard, money is less effective in overcoming informational frictions. Because low-quality goods producers can still consume as long as they hold money even when their products are recognized as low quality, agents have incentive to produce low-quality goods. I conduct several policy analyses, and find that the role of money is very sensitive to the inflation rate. While the Friedman rule is the optimal monetary policy in my environment, it cannot generate a first-best allocation unless traders are able to signal their quality of goods.