Essays in monetary theory: Search, prices, and currency substitution
Abstract
This thesis includes three essays analyzing the role of fiat money in decentralized trade. Essay 1 develops a model that describes a two-country-two-currency economy, in which prices are endogenized by using the “split-the-surplus” rule. The government generates seignorage revenue by issuing money to newborn citizen in return for goods. This process induces inflation and agents start using the foreign currency as a hedge against inflation on their own currency. This framework offers the possibility to analyze the main determinants of currency substitution and its implications on welfare and seignorage revenues. Essay 2 also studies endogenous currency substitution and price formation in a general equilibrium model with bilateral and decentralized international trade. In contrast to essay 1, there is a lack of government and prices are more realistically determined. In particular, sellers of homogenous goods choose to post prices in either of two currencies given that buyers' valuation is unobservable. It is shown that the absence of well-integrated international goods markets does not necessarily imply a violation of the law of one price. In equilibrium goods may be priced only in the local currency, but scarcity of local liquidity supports equilibria with currency substitution where the law of one price holds. By fostering trade, international circulation of money may enhance welfare. Finally, essay 3 analyses the relation between welfare and the taxation of money in a search-theoretic framework with flexible prices. In a model, closely related to that by Li (1995), prices are endogenously determined in the two most commonly used ways. First, buyers make take-it-or-leave-it offers to sellers. Second, using the price formation developed in essay 2, sellers post prices for their goods. In this decentralized trading environment buyers must exert effort to meet buyers, which gives rise to a trading externality. In contrast to Li's result with fixed prices, the externality cannot be internalized by taxing money holdings since prices are free to adjust to this additional trading friction.
Degree
Ph.D.
Advisors
Carlson, Purdue University.
Subject Area
Economic theory
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