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Money and Price Posting under Private Information

  • Mei Dong
  • Janet Hua Jiang

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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Paper provided by Bank of Canada in its series Staff 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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  1. 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.
  2. Guillaume Rocheteau, 2011. "The cost of inflation: a mechanism design approach," Working Paper 1103, Federal Reserve Bank of Cleveland.
  3. Wright, Randall, 2010. "A uniqueness proof for monetary steady state," Journal of Economic Theory, Elsevier, vol. 145(1), pages 382-391, January.
  4. Nosal, Ed, 2011. "Search, Welfare, And The “Hot Potato” Effect Of Inflation," Macroeconomic Dynamics, Cambridge University Press, vol. 15(S2), pages 313-326, September.
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  10. Narayana R. Kocherlakota, 1996. "Money is memory," Staff Report 218, Federal Reserve Bank of Minneapolis.
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  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. Eric Maskin & John Riley, 1984. "Monopoly with Incomplete Information," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 171-196, Summer.
  19. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  20. Curtis, Elisabeth & Wright, Randall, 2004. "Price setting, price dispersion, and the value of money: or, the law of two prices," Journal of Monetary Economics, Elsevier, vol. 51(8), pages 1599-1621, November.
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