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Money and Price Posting under Private Information

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  • Mei Dong
  • Janet Hua Jiang

Abstract

We study price posting with undirected search in a search-theoretic monetary model with divisible money and divisible goods. Ex ante homogeneous buyers experience match specific preference shocks in bilateral trades. The shocks follow a continuous distribution and the realization of the shocks is private information. We show that generically there exists a unique price posting monetary equilibrium. In equilibrium, each seller posts a continuous pricing schedule that exhibits quantity discounts. Buyers spend only when they have high enough preferences. As their preferences are higher, they spend more till they become cash constrained. Since inflation reduces the future purchasing power of money and the value of retaining money, buyers tend to spend their money faster in response to higher inflation. In particular, more buyers choose to spend money and buyers spend on average a higher fraction of their money. The model naturally captures the hot potato effect of inflation along both the intensive margin and the extensive margin.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 11-22.

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Length: 32 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:bca:bocawp:11-22

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Keywords: Economic models; Inflation and prices;

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References

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  1. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-41, February.
  2. Jafarey, Saqib & Masters, Adrian, 2003. " Output, Prices, and the Velocity of Money in Search Equilibrium," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(6), pages 871-88, December.
  3. Guillaume Rocheteau & Randall Wright, 2004. "Money in search equilibrium, in competitive equilibrium, and in competitive search equilibrium," Working Paper 0405, Federal Reserve Bank of Cleveland.
  4. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  5. Wright, Randall, 2010. "A uniqueness proof for monetary steady state," Journal of Economic Theory, Elsevier, vol. 145(1), pages 382-391, January.
  6. Nosal, Ed, 2011. "Search, Welfare, And The “Hot Potato” Effect Of Inflation," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S2), pages 313-326, September.
  7. Huberto M. Ennis, 2007. "Avoiding the inflation tax," Working Paper 07-06, Federal Reserve Bank of Richmond.
  8. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  9. Tai-wei Hu & John Kennan & Neil Wallace, 2009. "Coalition-Proof Trade and the Friedman Rule in the Lagos-Wright Model," Journal of Political Economy, University of Chicago Press, vol. 117(1), pages 116-137, 02.
  10. Elisabeth Curtis & Randall Wright, 2002. "Price setting, price dispersion, and the value of money - or - The law of two prices," Working Paper 0209, Federal Reserve Bank of Cleveland.
  11. Belen Jerez & Miquel Faig, 2005. "Inflation, Prices, and Information in Competitive Search," 2005 Meeting Papers 462, Society for Economic Dynamics.
  12. Jean, Kasie & Rabinovich, Stanislav & Wright, Randall, 2010. "On the multiplicity of monetary equilibria: Green-Zhou meets Lagos-Wright," Journal of Economic Theory, Elsevier, vol. 145(1), pages 392-401, January.
  13. Faig, Miquel & Jerez, Belen, 2005. "A theory of commerce," Journal of Economic Theory, Elsevier, vol. 122(1), pages 60-99, May.
  14. Eric Maskin & John Riley, 1984. "Monopoly with Incomplete Information," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 171-196, Summer.
  15. Huberto M. Ennis, 2004. "Search, money, and inflation under private information," Discussion Paper / Institute for Empirical Macroeconomics 142, Federal Reserve Bank of Minneapolis.
  16. Ricardo Lagos & Guillaume Rocheteau, 2004. "Inflation, output, and welfare," Working Paper 0407, Federal Reserve Bank of Cleveland.
  17. Che, Yeon-Koo & Gale, Ian, 2000. "The Optimal Mechanism for Selling to a Budget-Constrained Buyer," Journal of Economic Theory, Elsevier, vol. 92(2), pages 198-233, June.
  18. Thomas, Lionel, 2002. "Non-linear pricing with budget constraint," Economics Letters, Elsevier, vol. 75(2), pages 257-263, April.
  19. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  20. Guillaume Rocheteau, 2011. "The cost of inflation: a mechanism design approach," Working Paper 1103, Federal Reserve Bank of Cleveland.
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Cited by:
  1. Stephen Williamson & Randall Wright, 2010. "New monetarist economics: methods," Review, Federal Reserve Bank of St. Louis, issue May, pages 265-302.
  2. Stephen D. Williamson & Randall Wright, 2010. "New Monetarist Economics: models," Staff Report 443, Federal Reserve Bank of Minneapolis.
  3. Allen Head & Lucy Qian Liu & Guido Menzio & Randall Wright, 2012. "Sticky Prices: A New Monetarist Approach," Journal of the European Economic Association, European Economic Association, vol. 10(5), pages 939-973, October.
  4. Liu, Lucy Qian & Wang, Liang & Wright, Randall, 2011. "On The “Hot Potato” Effect Of Inflation: Intensive Versus Extensive Margins," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S2), pages 191-216, September.
  5. Enchuan Shao, 2013. "The Threat of Counterfeiting in Competitive Search Equilibrium," Working Papers 13-22, Bank of Canada.

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