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Bargaining and the value of money

  • Guillaume Rocheteau
  • Christopher Waller

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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  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. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  3. Peter Rupert & Martin Schindler & Randall Wright, 2000. "Generalized search-theoretic models of monetary exchange," Working Paper 0005, Federal Reserve Bank of Cleveland.
  4. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, vol. 52(2), pages 449-60, March.
  5. Moulin, H., 1984. "Implementing the Kalai-Smorodinsky bargaining solution," Journal of Economic Theory, Elsevier, vol. 33(1), pages 32-45, June.
  6. Ben Craig & Guillaume Rocheteau, 2006. "Inflation and welfare: a search approach," Policy Discussion Papers, Federal Reserve Bank of Cleveland, issue Jan.
  7. Thomson, William, 1994. "Cooperative models of bargaining," Handbook of Game Theory with Economic Applications, in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 2, chapter 35, pages 1237-1284 Elsevier.
  8. Aruoba, S. Boragan & Waller, Christopher J. & Wright, Randall, 2011. "Money and capital," Journal of Monetary Economics, Elsevier, vol. 58(2), pages 98-116, March.
  9. Ricardo Lagos & Guillaume Rocheteau, 2004. "Money and capital as competing media of exchange," Staff Report 341, Federal Reserve Bank of Minneapolis.
  10. Martin J. Osborne & Ariel Rubinstein, 2005. "Bargaining and Markets," Levine's Bibliography 666156000000000515, UCLA Department of Economics.
  11. Coles, Melvyn G. & Wright, Randall, 1998. "A Dynamic Equilibrium Model of Search, Bargaining, and Money," Journal of Economic Theory, Elsevier, vol. 78(1), pages 32-54, January.
  12. 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.
  13. Bernhard Rauch, 2000. "A Divisible Search Model of Fiat Money: A Comment," Econometrica, Econometric Society, vol. 68(1), pages 149-156, January.
  14. Aleksander Berentsen & Guillaume Rocheteau & Shouyong Shi, 2007. "Friedman Meets Hosios: Efficiency in Search Models of Money," Economic Journal, Royal Economic Society, vol. 117(516), pages 174-195, 01.
  15. Shouyong Shi, 1995. "Money and Prices: A Model of Search and Bargaining," Working Papers 916, Queen's University, Department of Economics.
  16. Benoit Julien & John Kennes & Ian King, 2006. "Monetary Exchange with Multilateral Matching," 2006 Meeting Papers 883, Society for Economic Dynamics.
  17. Kalai, Ehud & Samet, Dov, 1985. "Monotonic Solutions to General Cooperative Games," Econometrica, Econometric Society, vol. 53(2), pages 307-27, March.
  18. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 279-98, April.
  19. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  20. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
  21. Alvin E Roth, 2008. "Axiomatic Models of Bargaining," Levine's Working Paper Archive 122247000000002376, David K. Levine.
  22. P. A. Diamond, 1982. "Money in Search Equilibrium," Working papers 297, Massachusetts Institute of Technology (MIT), Department of Economics.
  23. 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.
  24. Chun, Youngsub & Thomson, William, 1988. "Monotonicity properties of bargaining solutions when applied to economics," Mathematical Social Sciences, Elsevier, vol. 15(1), pages 11-27, February.
  25. Narayana R. Kocherlakota, 1996. "Money is memory," Staff Report 218, Federal Reserve Bank of Minneapolis.
  26. Barry O'Neill & Dov Samet & Zvi Wiener & Eyal Winter, 2001. "Bargaining with an Agenda," Game Theory and Information 0110004, EconWPA.
  27. Kalai, Ehud & Smorodinsky, Meir, 1975. "Other Solutions to Nash's Bargaining Problem," Econometrica, Econometric Society, vol. 43(3), pages 513-18, May.
  28. 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, vol. 42(4), pages 847-69, November.
  29. Kiyotaki, Nobuhiro & Wright, Randall, 1993. "A Search-Theoretic Approach to Monetary Economics," American Economic Review, American Economic Association, vol. 83(1), pages 63-77, March.
  30. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  31. Kalai, Ehud, 1977. "Proportional Solutions to Bargaining Situations: Interpersonal Utility Comparisons," Econometrica, Econometric Society, vol. 45(7), pages 1623-30, October.
  32. 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.
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