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Pairwise Trade, Asset Prices and Monetary Policy

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  • Guillaume Rocheteau
  • Ed Nosal

    (Chicago Fed)

Abstract

We construct a search-theoretic model where fiat money coexists with real assets, and all assets can be used as a media of exchange. The terms of trade in bilateral matches are determined by a pairwise Pareto-efficient pricing mechanism. We do not have to appeal to exogenous liquidity constraints to generate asset prices that are consistent with the following facts: (i) fiat money can be valued despite being dominated in its rate of return; (ii) real assets with identical dividend flows can have different rates of return; and (iii) an increase in inflation raises asset prices, lowers their returns, and widens the rate-of-return differences between assets. On the normative side we show that there is a range of inflation rates that implement the first-best allocation.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 774.

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Date of creation: 2008
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Handle: RePEc:red:sed008:774

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  1. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
  2. Ricardo Lagos & Guillaume Rocheteau, 2006. "Money and capital as competing media of exchange," Working Paper 0608, Federal Reserve Bank of Cleveland.
  3. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  4. S. Boragan Aruoba & Randall Wright, 2002. "Search, money and capital: a neoclassical dichotomy," Working Paper 0208, Federal Reserve Bank of Cleveland.
  5. Zhu, Tao & Wallace, Neil, 2007. "Pairwise trade and coexistence of money and higher-return assets," Journal of Economic Theory, Elsevier, vol. 133(1), pages 524-535, March.
  6. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  7. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2004. "Over-the-Counter Markets," NBER Working Papers 10816, National Bureau of Economic Research, Inc.
  8. Williamson, S. & Wright, R., 1991. "Barter and Monetary Exchange Under Private Information," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9107, University of Western Ontario, The Centre for the Study of International Economic Relations.
  9. Wallace, Neil, 2000. "A model of the liquidity structure based on asset indivisibility," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 55-68, February.
  10. Barry O'Neill & Dov Samet & Zvi Wiener & Eyal Winter, 2001. "Bargaining with an Agenda," Game Theory and Information 0110004, EconWPA.
  11. S. Boragan Aruoba & Randall Wright, 2002. "Search, Money and Capital: A Neoclassical Dichotomy, Second Version," PIER Working Paper Archive 03-028, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 03 Sep 2003.
  12. Guillaume Rocheteau & Randall Wright, 2005. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Econometrica, Econometric Society, vol. 73(1), pages 175-202, 01.
  13. David Andolfatto, 2009. "Essential interest-bearing money," Working Papers 2009-044, Federal Reserve Bank of St. Louis.
  14. Aruoba, S. Boragan & Chugh, Sanjay K., 2010. "Optimal fiscal and monetary policy when money is essential," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1618-1647, September.
  15. 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.
  16. Pierre-Olivier Weill, 2004. "Liquidity Premia in Dynamic Bargaining Markets," Econometric Society 2004 North American Winter Meetings 648, Econometric Society.
  17. Boragan Aruoba, S. & Rocheteau, Guillaume & Waller, Christopher, 2007. "Bargaining and the value of money," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2636-2655, November.
  18. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  19. Rocheteau, Guillaume, 2011. "Payments and liquidity under adverse selection," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 191-205.
  20. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
  21. Marshall, David A, 1992. " Inflation and Asset Returns in a Monetary Economy," Journal of Finance, American Finance Association, vol. 47(4), pages 1315-42, September.
  22. Benjamin Lester & Andrew Postlewaite & Randall Wright, 2012. "Information, Liquidity, Asset Prices, and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 79(3), pages 1209-1238.
  23. Banerjee, Abhijit V & Maskin, Eric S, 1996. "A Walrasian Theory of Money and Barter," The Quarterly Journal of Economics, MIT Press, vol. 111(4), pages 955-1005, November.
  24. Athanasios Geromichalos & Juan M Licari & Jose Suarez-Lledo, 2007. "Monetary Policy and Asset Prices," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(4), pages 761-779, October.
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Cited by:
  1. Guillaume Rocheteau, 2011. "On the coexistence of money and higher-return assets and its social role," Working Paper 1104, Federal Reserve Bank of Cleveland.
  2. Ricardo Lagos, 2008. "The Research Agenda: Ricardo Lagos on Liquidity and the Search Theory of Money," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 10(1), November.
  3. Guillaume Rocheteau & Jose Antonio Rodriguez-Lopez, 2013. "Liquidity Provision, Interest Rates, and Unemployment," Working Papers 121311, University of California-Irvine, Department of Economics.

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