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Bargaining and the value of money

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  • Guillaume Rocheteau
  • Christopher Waller

Abstract

Search models of monetary exchange have typically relied on Nash (1950) bargaining or strategic games that yield an equivalent outcome to determine the terms of trade. By considering alternative axiomatic bargaining solutions in a simple search model with divisible money, we show how this choice matters for important results such as the ability of the optimal monetary policy to generate an efficient allocation. We show that the quantities traded in bilateral matches are always inefficiently low under the Nash (1950) and Kalai-Smorodinsky (1975) solutions, whereas under strongly monotonic solutions such as the egalitarian solution (Luce and Raiffa, 1957; Kalai, 1977), the Friedman Rule achieves the first best allocation. We evaluate quantitatively the welfare cost of inflation under the different bargaining solutions, and we extend the model to allow for endogenous market composition.

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Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 0501.

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Date of creation: 2005
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Handle: RePEc:fip:fedcwp:0501

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Keywords: Money ; Monetary policy ; Game theory;

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  1. Aleksander Berentsen & Guillaume Rocheteau & Shouyong Shi, 2002. "Friedman Meets Hosios: Efficiency in Search Models of Money," Working Papers shouyong-02-04, University of Toronto, Department of Economics.
  2. Barry O'Neill & Dov Samet & Zvi Wiener & Eyal Winter, 2001. "Bargaining with an Agenda," Game Theory and Information, EconWPA 0110004, EconWPA.
  3. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers, Queen's University, Department of Economics 930, Queen's University, Department of Economics.
  4. Ehud Kalai & Dov Samet, 1983. "Monotonic Solutions to General Cooperative Games," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 567, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Moulin, H., 1984. "Implementing the Kalai-Smorodinsky bargaining solution," Journal of Economic Theory, Elsevier, Elsevier, vol. 33(1), pages 32-45, June.
  6. Bernhard Rauch, 2000. "A Divisible Search Model of Fiat Money: A Comment," Econometrica, Econometric Society, Econometric Society, vol. 68(1), pages 149-156, January.
  7. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 113(3), pages 463-484, June.
  8. 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.
  9. 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.
  10. Kalai, Ehud, 1977. "Proportional Solutions to Bargaining Situations: Interpersonal Utility Comparisons," Econometrica, Econometric Society, Econometric Society, vol. 45(7), pages 1623-30, October.
  11. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, Elsevier, vol. 81(2), pages 232-251, August.
  12. Ricardo Lagos & Guillaume Rocheteau, 2004. "Money and capital as competing media of exchange," Staff Report, Federal Reserve Bank of Minneapolis 341, Federal Reserve Bank of Minneapolis.
  13. Chun, Youngsub & Thomson, William, 1988. "Monotonicity properties of bargaining solutions when applied to economics," Mathematical Social Sciences, Elsevier, Elsevier, vol. 15(1), pages 11-27, February.
  14. Aruoba, S. Boragan & Waller, Christopher J. & Wright, Randall, 2011. "Money and capital," Journal of Monetary Economics, Elsevier, Elsevier, vol. 58(2), pages 98-116, March.
  15. Alvin E Roth, 2008. "Axiomatic Models of Bargaining," Levine's Working Paper Archive 122247000000002376, David K. Levine.
  16. Coles, Melvyn G. & Wright, Randall, 1998. "A Dynamic Equilibrium Model of Search, Bargaining, and Money," Journal of Economic Theory, Elsevier, Elsevier, vol. 78(1), pages 32-54, January.
  17. Ben Craig & Guillaume Rocheteau, 2006. "Inflation and welfare: a search approach," Policy Discussion Papers, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, issue Jan.
  18. P. A. Diamond, 1982. "Money in Search Equilibrium," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 297, Massachusetts Institute of Technology (MIT), Department of Economics.
  19. Shouyong Shi, 1995. "Money and Prices: A Model of Search and Bargaining," Working Papers, Queen's University, Department of Economics 916, Queen's University, Department of Economics.
  20. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, Econometric Society, vol. 18(2), pages 155-162, April.
  21. BenoƮt Julien & John Kennes & Ian King, 2005. "Monetary Exchange with Multilateral Matching," Discussion Papers 05-18, University of Copenhagen. Department of Economics, revised Oct 2005.
  22. Kalai, Ehud & Smorodinsky, Meir, 1975. "Other Solutions to Nash's Bargaining Problem," Econometrica, Econometric Society, Econometric Society, vol. 43(3), pages 513-18, May.
  23. Martin J. Osborne & Ariel Rubinstein, 2005. "Bargaining and Markets," Levine's Bibliography 666156000000000515, UCLA Department of Economics.
  24. Guillaume Rocheteau & Randall Wright, 2003. "Inflation and Welfare in Models with Trading Frictions," PIER Working Paper Archive 03-032, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  25. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, Econometric Society, vol. 68(2), pages 247-274, March.
  26. Kiyotaki, Nobuhiro & Wright, Randall, 1993. "A Search-Theoretic Approach to Monetary Economics," American Economic Review, American Economic Association, American Economic Association, vol. 83(1), pages 63-77, March.
  27. Wallace, Neil, 2001. "Whither Monetary Economics?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 847-69, November.
  28. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  29. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, Econometric Society, vol. 52(2), pages 449-60, March.
  30. Thomson, William, 1994. "Cooperative models of bargaining," Handbook of Game Theory with Economic Applications, Elsevier, in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 2, chapter 35, pages 1237-1284 Elsevier.
  31. Rupert, Peter & Schindler, Martin & Wright, Randall, 2001. "Generalized search-theoretic models of monetary exchange," Journal of Monetary Economics, Elsevier, Elsevier, vol. 48(3), pages 605-622, December.
  32. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 103(1), pages 118-41, February.
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