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A unified framework for monetary theory and policy analysis

  • Ricardo Lagos
  • Randall Wright

Search-theoretic models of monetary exchange are based on explicit descriptions of the frictions that make money essential. However, tractable versions of these models typically need strong assumptions that make them ill-suited for studying monetary policy. We propose a framework based on explicit micro foundations within which macro policy can be analyzed. The model is both analytically tractable and amenable to quantitative analysis. We demonstrate this by using it to estimate the welfare cost of inflation. We find much higher costs than the previous literature: our model predicts that going from 10% to 0% inflation can be worth between 3% and 5% of consumption.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 346.

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Date of creation: 2004
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Publication status: Published in Journal of Political Economy> (Vol. 113, No. 3, June 2005, pp. 463-484)
Handle: RePEc:fip:fedmsr:346
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  1. Cooley, Thomas F & Hansen, Gary D, 1991. "The Welfare Costs of Moderate Inflations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 483-503, August.
  2. Ruilin Zhou, 1996. "Individual and Aggregate Real Balances in a Random Matching Model," GE, Growth, Math methods 9612001, EconWPA, revised 23 Dec 1996.
  3. Shouyong Shi, 1996. "A Divisible Search Model of Fiat Money," Working Papers 930, Queen's University, Department of Economics.
  4. Shouyong Shi, 1998. "Search, Inflation, and Capital Accumulation," Working Papers 971, Queen's University, Department of Economics.
  5. Berentsen, Aleksander, 2002. "On the Distribution of Money Holdings in a Random-Matching Model," MPRA Paper 37319, University Library of Munich, Germany.
  6. Paul Gomme, 1991. "Money and growth revisited," Discussion Paper / Institute for Empirical Macroeconomics 55, Federal Reserve Bank of Minneapolis.
  7. Aleksander Berentsen & Guillaume Rocheteau, . "On the Efficiency of Monetary Exchange:How Divisibility of Money Matters," IEW - Working Papers 101, Institute for Empirical Research in Economics - University of Zurich.
  8. Ricardo Lagos & Randall Wright, 2002. "Dynamics, cycles and sunspot equilibria in "genuinely dynamic, fundamentally disaggregative" models of money," Working Paper 0210, Federal Reserve Bank of Cleveland.
  9. 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.
  10. Cooley, T.F. & Hansen, G.D., 1988. "The Inflation Tax In A Real Business Cycle Model," Papers 88-05, Rochester, Business - General.
  11. Camera, Gabriele & Corbae, Dean, 1999. "Money and Price Dispersion," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(4), pages 985-1008, November.
  12. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Current Real-Business-Cycle Theories and Aggregate Labor-Market Fluctuations," American Economic Review, American Economic Association, vol. 82(3), pages 430-50, June.
  13. 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.
  14. S. Rao Aiyagari & Neil Wallace, 1991. "Existence of steady states with positive consumption in the Kiyotaki-Wright model," Working Papers 428, Federal Reserve Bank of Minneapolis.
  15. S. Boragan Aruoba & Randall Wright, 2003. "Search, money, and capital: a neoclassical dichotomy," Proceedings, Federal Reserve Bank of Cleveland, pages 1085-1117.
  16. Aleksander Berentsen & Guillaume Rocheteau, . "Money and the Gains from Trade," IEW - Working Papers 100, Institute for Empirical Research in Economics - University of Zurich.
  17. Wu, Yangru & Zhang, Junxi, 2000. "Monopolistic competition, increasing returns to scale, and the welfare costs of inflation," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 417-440, October.
  18. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  19. Duffie, Darrell, et al, 1994. "Stationary Markov Equilibria," Econometrica, Econometric Society, vol. 62(4), pages 745-81, July.
  20. Shouyong Shi, 1995. "Money and Prices: A Model of Search and Bargaining," Working Papers 916, Queen's University, Department of Economics.
  21. Nobuhiro Kiyotaki & John Moore, 2012. "Liquidity, Business Cycles, and Monetary Policy," NBER Working Papers 17934, National Bureau of Economic Research, Inc.
  22. 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.
  23. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  24. Susanto Basu & John G. Fernald, 1996. "Returns to scale in U.S. production: estimates and implications," International Finance Discussion Papers 546, Board of Governors of the Federal Reserve System (U.S.).
  25. Kocherlakota, Narayana R., 1998. "Money Is Memory," Journal of Economic Theory, Elsevier, vol. 81(2), pages 232-251, August.
  26. 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.
  27. Nobuhiro Kiyotaki & Randall Wright, 1989. "A contribution to the pure theory of money," Staff Report 123, Federal Reserve Bank of Minneapolis.
  28. Richard Rogerson, 2010. "Indivisible Labor, Lotteries and Equilibrium," Levine's Working Paper Archive 250, David K. Levine.
  29. Berentsen Aleksander & Rocheteau Guillaume, 2003. "On the Friedman Rule in Search Models with Divisible Money," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-21, December.
  30. Shi Shouyong, 1997. "Search for a Monetary Propagation Mechanism," Working Papers 966, Queen's University, Department of Economics.
  31. 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.
  32. Miguel Molico, 2006. "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 701-722, 08.
  33. Taber, Alexander & Wallace, Neil, 1999. "A Matching Model with Bounded Holdings of Indivisible Money," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(4), pages 961-84, November.
  34. 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.
  35. Green, Edward J. & Zhou, Ruilin, 1998. "A Rudimentary Random-Matching Model with Divisible Money and Prices," Journal of Economic Theory, Elsevier, vol. 81(2), pages 252-271, August.
  36. Alvarez, Fernando & Stokey, Nancy L., 1998. "Dynamic Programming with Homogeneous Functions," Journal of Economic Theory, Elsevier, vol. 82(1), pages 167-189, September.
  37. Bernhard Rauch, 2000. "A Divisible Search Model of Fiat Money: A Comment," Econometrica, Econometric Society, vol. 68(1), pages 149-156, January.
  38. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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  1. Advanced Monetary Theory and Policy (ECON 447)

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