Ross M. Starr

The Transactions Role of Money

Publisher Summary The transaction role of money is one of the most palpable of economic phenomena and offers one of the first challenges for the theory of exchange. A useful analogy can be made between the role of money as a record-keeping device and the theory of signaling. The chapter discusses that the theory of exchange was developed as a response to the challenges of price determination and allocation of resources. The frictions required for monetary exchange—such as differential costs of spot and forward transactions and the strategic issues of incomplete information and incentive compatibility—are recent developments. It explains the slow growth of the transaction role of money as a branch of the theory of exchange. The transaction role of money challenges the implicit logistical and informational assumptions of the theory of exchange. The sequential nature of trade makes informational demands that go beyond the knowledge of prices that suffices in the traditional theory of exchange. The chapter also examines the rationale behind the transaction role of money in a model exhibiting this dichotomy. Exploring the properties of models in which budget enforcement problems are always a binding constraint on behavior helps illuminate the understanding of macroeconomics.

Optimal Production and Allocation under Uncertainty

I. Ex ante and ex post optimum, 81. — II. Consumers and commodities, 83. — III. Consumer choice and the subjectivity theorem, 85. — IV. Necessary conditions for ex post Pareto optimum given Arrow optimum, 88. — V. Production, 89. — VI. Efficiency, 91. — VII. Economies where the necessary conditions for Arrow optimum to imply ex post Pareto optimum are sufficient, 93. — Table of notation, 94.

The Structure of Exchange in Barter and Monetary Economies

I. Transactions and money in general equilibrium models, 290. — II. Representation of equilibrium and exchange, 292. — III. The barter economy, 293. — IV. The money economy, 297. — V. Relation of monetary to barter exchange, 299. — VI. Behavior of money balances, 300. — VII. Conclusion, 301.

The Price of Money in a Pure Exchange Monetary Economy with Taxation

Publisher Summary This chapter discusses the price of money in a pure exchange monetary economy with taxation. A transactions demand for money is built into the model. Further, the demand becomes discontinuously inoperative when the nil price of money occurs, as nil-price money is useless in exchange. The discontinuity in demand behavior in this neighborhood is a technical problem. Fixed-point theorems may not be directly applicable over the unrestricted price space. The transactions demand is not sufficient to ensure price positivity. However, fiat money is issued by a government possessing taxing authority. The demand for fiat money to pay taxes creates sufficient demand for fiat money so that there is positive price equilibrium and the nil price is no longer an equilibrium. When the price of money is positive, traders will deplete their money holdings to the point where the nonnegativity constraint is binding. If the constraint is not restrictive enough, however, this will result in an excess supply of money on the market and an excess demand for goods, clearly disequilibrium.

Why is There Money? Endogenous Derivation of 'Money' as the Most Liquid Asset: A Class of Examples

The monetary character of trade, the existence of a common medium of exchange, is derived as an outcome of the economic general equilibrium in a class of examples. Two constructs are added to an Arrow-Debreu general equilibrium model: market segmentation with multiple budget constraints (one at each transaction) and transaction costs. The multiplicity of budget constraints creates a demand for a carrier of value between transactions. A common medium of exchange, money, arises endogenously as the most liquid (lowest transaction cost) asset. Government-issued fiat money has a positive equilibrium value due to its acceptability in payment of taxes. Scale economies in transaction cost account for uniqueness of the (fiat or commodity) money in equilibrium. The monetary structure of trade and the uniqueness of money in equilibrium can thus be derived from elementary price theory.

Liquidity of Secondary Capital Markets: Allocative Efficiency and the Maturity Composition of the Capital Stock

SummaryWe investigate the function of liquid financial markets for the allocation of productive capital. We consider an economy where agents endogenously choose among capital production technologies with differing gestation periods. Long-gestation capital investments must be “rolled-over” in secondary capital markets. The use of such investment technologies therefore requires the support of liquid financial markets. We investigate how changes in the liquidity of these markets (i.e., in the costs of transacting) affect (a) the choice of capital production technology, (b) per capita income and the per capita capital stock, (c) the level of financial market activity, (d) the real return on savings and (e) welfare in a steady state equilibrium. Improvements in financial market liquidity raise rates of return on savings, and favor the increased use of long gestation capital investments. However, such improvements may or may not lead to higher levels of real activity or steady state welfare. We describe conditions under which various outcomes occur.

Capital Market Imperfection, the Consumption Function, and the Effectiveness of Fiscal Policy

I. Income and consumption, 455.—II. Optimal consumption plans subject to borrowing constraint, 457.—III. Dependence of consumption on income in the short run: a consumption function, 460.—IV. Summary, 462.

Equilibrium with Non-convex Transactions Costs: Monetary and Non-monetary Economies

Publisher Summary This chapter discusses the equilibrium with nonconvex transactions costs for monetary and nonmonetary economies. The idea that transaction costs display a scale economy is commonplace. This cost structure enters essentially as an explanation of the demand for inventories of goods, and for idle balances of money. Hence, a theory of a monetary economy with nonconvex transaction costs is a necessary generalization of the transaction cost theory so far developed. The now standard technique in a discrete finite economy is to approximate the nonconvex economy by a convex economy. Equilibrium is established for the (artificial) convex economy, and finally it is shown that a small reallocation from this point represents an approximate equilibrium for the nonconvex economy. The equilibrium includes idle balances of money and inventories of goods. Both are held to economize on transaction costs. The model uses the individualized transactions technologies of Kurz to formalize the idea of a nonconvexity facing individual agents. Nonconvexities in transactions cost may provide a strong motive for making transactions and payments in large discrete amounts rather than smaller or, indeed, continuous amounts.

Pairwise, t-Wise, and Pareto Optimalities

An allocation is said to be t-wise optimal (for t a positive integer) if for every collection of t traders, there is no reallocation of their current holdings that will make some better off while making none worse off. The allocation is pairwise optimal if it is t-wise optimal for t = 2. A t-wise optimal allocation is the outcome of a trading process more decentralized than that of the Walrasian equilibrium. It represents the result of a variety of separate transactions in small groups without the (centralized) coordination provided by a single Walrasian auctioneer. Necessary conditions and sufficient conditions on allocations for t-wise optimality to imply Pareto optimality are developed. These generally require sufficient overlap in goods holdings among traders to ensure the presence of common support prices. This is formalized as indecomposability of a truncated submatrix of the allocation matrix. A necessary and sufficient condition remains an open question. OUR PRINCIPAL CONCERN in this inquiry is with the decentralization of the trading process. The analysis departs from the familiar Arrow-Debreu general equilibrium framework to examine the efficiency of economies deprived of the coordinating function of the Walrasian price mechanism. The alternative, presented here, is to permit trade to take place only in small groups-say up to t traders in number. We envision an exchange economy wherein groups form and reform in order to barter-as individuals and as small coalitions. If all such small groups may form, then such a process might eventually converge to an equilibrium from which no reallocation involving t or fewer traders could result in a Pareto preferable allocation. That is, an allocation which is t-wise optimal. The dynamics of pairwise barter trade to achieve a pairwise optimal allocation is thoroughly studied in Feldman [2]. The corresponding analysis for trade in larger groups represents an open research topic, though we certainly expect Feldmans analysis to generalize. It is by no means apparent that such a t-wise optimal allocation would be Pareto optimal. This reflects the difficulty of achieving a reallocation which is preferable for a large group through a sequence of weakly desirable small group trades. Since Pareto optimality is such an essential condition in welfare economics, it is useful to discover under what circumstances the two optimality concepts

Liquidity of the treasury bill market and the term structure of interest rates

Abstract We model the term structure of interest rates on Treasury bills as attributable to transaction cost, in particular to the bid-ask spread on T-bills. Since the bid-ask spread on a bill is increasing in maturity, part of the term premium can be modeled as a premium for differential liquidity, the transaction cost difference between bills of different maturity. Empirical results show that the bid-ask spread on Treasury bills is priced in the bill market and accounts for a substantial portion of the term premium, sometimes to the exclusion of a risk premium in the term structure.