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Inflation, Prices, and Information in Competitive Search

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Author Info
Miquel Faig
Belén Jerez

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Abstract

We study the effects of inflation in a competitive search model where each buyer\'s utility is private information, and where money is essential in facilitating trade. The equilibrium is efficient at the Friedman rule, but inflation creates an inefficiency in the terms of trade. Buyers experience a preference shock after they are matched with a seller, and thus they have a precautionary motive for holding money. Sellers, who compete to attract buyers, post non-linear price schedules to screen out different types of buyers. As inflation rises, sellers post relatively flat price schedules which reduce the need for buyers to hold precautionary balances. These price schedules induce buyers with a low desire to consume to purchase inefficiently high quantities because of the low marginal cost of purchasing goods. In contrast, buyers with a high desire to consume purchase inefficiently low quantities as they face binding liquidity constraints. The reduction of precautionary balances as inflation rises allows the model to fit historical US data on velocity and interest rates.

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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-215.

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Length: 34 pages
Date of creation: 31 Mar 2006
Date of revision:
Handle: RePEc:tor:tecipa:tecipa-215

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Related research
Keywords: inflation; precautionary money demand; competitive search; private information.;

Other versions of this item:

Find related papers by JEL classification:
E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models

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  1. Camera, Gabriele & Winkler, Johannes, 2003. "International monetary trade and the law of one price," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1531-1553, October. [Downloadable!] (restricted)
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    Other versions:
  3. Aleksander Berentsen & Gabriele Camera, 2004. "Money, Credit, and Banking," 2004 Meeting Papers 473, Society for Economic Dynamics.
    Other versions:
  4. 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. [Downloadable!]
  5. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
    Other versions:
  6. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland. [Downloadable!]
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  7. Williamson, Steve & Wright, Randall, 1994. "Barter and Monetary Exchange under Private Information," American Economic Review, American Economic Association, vol. 84(1), pages 104-23, March. [Downloadable!] (restricted)
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  8. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August. [Downloadable!] (restricted)
  9. Huberto M. Ennis, 2005. "Search, Money, and Inflation under Private Information," 2005 Meeting Papers 135, Society for Economic Dynamics. [Downloadable!]
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  10. Eric Maskin & John Riley, 1984. "Monopoly with Incomplete Information," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 171-196, Summer. [Downloadable!] (restricted)
  11. Faig, Miquel & Jerez, Belen, 2005. "A theory of commerce," Journal of Economic Theory, Elsevier, vol. 122(1), pages 60-99, May. [Downloadable!] (restricted)
  12. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
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  13. Faig, Miquel, 1989. "Seasonal Fluctuations and the Demand for Money," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 847-61, November. [Downloadable!] (restricted)
  14. 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. [Downloadable!] (restricted)
  15. Aleksander Berentsen & Guillaume Rocheteau, 2004. "Money and Information," Review of Economic Studies, Blackwell Publishing, vol. 71(4), pages 915-944, October. [Downloadable!] (restricted)
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  16. Miquel Faig & Belén Jerez, 2005. "Precautionary Balances And The Velocity Of Circulation Of Money," Economics Working Papers we051406, Universidad Carlos III, Departamento de Economía. [Downloadable!]
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  17. Guillaume Rocheteau & Randall Wright, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," PIER Working Paper Archive 03-031, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
    Other versions:
  18. Mankiw, N Gregory & Summers, Lawrence H, 1986. "Money Demand and the Effects of Fiscal Policies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 18(4), pages 415-29, November. [Downloadable!] (restricted)
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