Victor E. Li

The Efficiency of Monetary Exchange in Search Equilibrium

Search theoretic models of money emphasize monetary exchange as the outcome of economic environments characterized by bilateral trading frictions. This paper analyzes the efficiency of monetary exchange in a search model of fiat money where individuals invest costly effort in the exchange process. Because the optimal effort each individual trader invests in exchange is based upon the private rather than social gains from trade, decentralized monetary equilibria are shown to be inefficient relative to the social optimum. However, for an appropriate division of the gains from trade given to buyers and sellers, it is possible to attain social efficiency. The nature of these search externalities for monetary exchange and their implications for policy are evaluated and discussed. Copyright 1997 by Ohio State University Press.

The cyclical behavior of household and business investment in a cash-in-advance economy

Abstract This paper focuses on a monetary explanation of two business cycle regularities: (i) business and household investment are positively correlated and procyclical and (ii) business investment tends to lag household investment over the cycle. Our general equilibrium framework is essentially a standard cash-in-advance economy where households purchase both non-durable and durable consumption goods and businesses accumulate productive capital. Financial intermediaries provide interest bearing deposits to households and loanable funds to finance business investment. It is shown that the adaptation of particular interest rate rules by the monetary authority provides a mechanism to capture both the timing and direction of business and household investment. The results are then discussed within the context of recent limited participation models which emphasize the liquidity effects of monetary shocks.

Financial Matchmakers in Credit Markets with Heterogeneous Borrowers

What happens when liquidity increases in credit markets and more funds are channeled from borrowers to lenders? We examine this question in a general equilibrium model where financial matchmakers help borrowers (firms) and lenders (households) search out and negotiate profitable matches and where the composition of heterogeneous borrowers adjusts to satisfy equilibrium entry conditions. We find that enhanced liquidity causes entry by all borrowers and tends to benefit low-quality borrowers disproportionately. However, liquid credit markets may or may not be associated with higher output and welfare. The result is determined by whether the effect of higher market participation outweighs that of lower average quality. The net effect depends crucially on the source of the liquidity shock (financial matching efficacy, productivity, or entry barriers).

DECENTRALIZED EXCHANGE AND FACTOR PAYMENTS: A MULTIPLE-MATCHING APPROACH

The emergence of fiat money is studied in an environment in which exchange is organized around trading posts where many producers and shoppers are matched in a dynamic monopolistically competitive framework. Each household consumes a bundle of commodities and has a preference for consumption variety. Within this multiple matching structure we determine the endogenous organization of exchange between firms and shoppers and the means of factor payment (remuneration) as well as the price at which these trades occur. Although each household contacts many sellers, the specialization of tastes implies that the variety of the consumption basket under barter mediated exchange is sparser than that obtained under monetary exchange. We verify that the endogenous linkage of factor payments with the medium of exchange can lead to a monetary equilibrium outcome where only fiat money trades for goods, an ex-ante feature of cash-in-advance models. We also examine the long-run effects of money growth on the equilibrium pattern of exchange. A primary finding, consistent with documented hyperinflationary episodes, is that a sufficiently rapid expansion of money supply and inflation leads to the gradual emergence of barter. Under these circumstances sellers will accept both goods and cash payments whereas workers receive part of their remuneration in goods.