Money, Payments, and Liquidity

Money, Payments, and Liquidity

Ed Nosal
Guillaume Rocheteau
Copyright Date: 2011
Published by: MIT Press
Pages: 384
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  • Book Info
    Money, Payments, and Liquidity
    Book Description:

    In Money, Payments, and Liquidity, Ed Nosal and Guillaume Rocheteau provide a comprehensive investigation into the economics of money and payments by explicitly modeling trading frictions between agents. Adopting the search-theoretic approach pioneered by Nobuhiro Kiyotaki and Randall Wright, Nosal and Rocheteau provide a logically coherent dynamic framework to examine the frictions in the economy that make money and liquid assets play a useful role in trade. They discuss the implications of such frictions for the suitable properties of a medium of exchange, monetary policy, the cost of inflation, the inflation-output trade-off, the coexistence of money, credit, and higher return assets, settlement, and liquidity.After presenting the basic environment used throughout the book, Nosal and Rocheteau examine pure credit and pure monetary economies, and discuss the role of money, different pricing mechanisms, and the properties of money. In subsequent chapters they study monetary policy, the Friedman rule in particular, and the relationship between inflation and output under different information structures; economies where monetary exchange coexists with credit transactions; the coexistence of money and other assets such as another currency, capital, and bonds; and a continuous-time version of the model that describes over-the-counter markets and different dimensions of liquidity (bid-ask spreads, trade volume, trading delays).

    eISBN: 978-0-262-29828-5
    Subjects: Economics, Finance

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-x)
  3. Acknowledgments
    (pp. xi-xii)
  4. Introduction
    (pp. 1-12)

    Economics is all about gains from trade. But if gains from trade are to be realized, people must exchange one object for another. How does this exchange materialize?

    Exchange can be easy. If John has apples but likes strawberries more, and his classmate Paul has strawberries but likes apples more, then John and Paul can directly exchange strawberries for apples when they meet. There is a double coincidence of wants: John has what Paul wants and Paul has what John wants. In figure 1.1 we represent the endowments and preferences of John and Paul. The × beside the names are...

  5. 1 The Basic Environment
    (pp. 13-20)

    This book studies issues directly related to society’s need for media of exchange. Any such study requires a departure from the standard Arrow–Debreu model economy. In the Arrow–Debreu model, markets are frictionless and complete, agents can all get together at the beginning of time to buy and sell contracts, and they can commit to deliver or accept delivery of goods over all possible dates and contingencies. The basic structure of the Arrow–Debreu model implies that the economy can achieve a Pareto-efficient allocation without needing objects like money or other financial institutions.

    A good model of media of...

  6. 2 Pure Credit Economies
    (pp. 21-46)

    Consider an encounter between two individuals. One is hungry in the morning and wants to consume, but is only able to produce at night. Call him thebuyer. The other can produce in the morning, but is only hungry at night. Call him theseller. If the buyer has nothing tangible to offer the seller in exchange for consumption goods, then the buyer and seller are unable to engage in a morning spot trade. In this event a simple solution would be for the buyer to promise to deliver some consumption goods in the future in exchange for some consumption...

  7. 3 The Role of Money
    (pp. 47-60)

    In the previous chapter we showed that credit arrangements allow agents to take advantage of intertemporal gains from trade. If, however, creditors do not trust debtors to repay their debts, then trade by credit may not be incentive feasible. If agents are to trade with one another, then some sort of tangible medium of exchange must emerge. According to Kiyotaki and Moore (2002, p. 64), a lack of trust is of primary importance for a theory of money: As they say, “distrust is the root of all money.”

    In this chapter we assume that buyers and sellers never trust one...

  8. 4 Money in Equilibrium
    (pp. 61-98)

    In the previous chapter we uncovered the technological role of fiat money by describing the set of allocations that are incentive feasible with indivisible money. The objective of this chapter is to study money in equilibrium under trading protocols that have either explicit axiomatic or strategic foundations, and to explore the normative and positive implications of such protocols. In contrast to chapter 3, we do not restrict money to be indivisible, nor do we restrict equilibria to be stationary. The model presented in this chapter is the core framework to study issues related to money, payments, and liquidity for the...

  9. 5 Properties of Money
    (pp. 99-126)

    The role that an asset plays as a medium of exchange depends on the nature of the frictions in the economy and on its physical characteristics. In chapters 3 and 4 the absence of record keeping and commitment implied that a tangible medium of exchange was needed to facilitate trade, and fiat money fulfilled that role. In those chapters although some physical properties of fiat money were made explicit—such as its divisibility or lack thereof—other important, and desirable, properties were left implicit. For example, it was implicitly assumed that fiat money did not depreciate or wear out over...

  10. 6 The Optimum Quantity of Money
    (pp. 127-160)

    By not specifying the frictions that make monetary exchange useful, reduced-form models do not fully articulate how monetary policy affects the economy. Here we adopt instead the strategy of constructing economic environments where the presence of fiat money is essential, and the societal benefits of monetary exchange are explicitly spelled out. By following this strategy, we are able to show that the same frictions that support positively valued fiat money can also provide new insights for monetary policy.

    So far we have only considered a one-time change in the money supply. In this chapter we go one step further and...

  11. 7 Information, Monetary Policy, and the Inflation–Output Trade-Off
    (pp. 161-194)

    How does money affect output? This is a classic and largely unresolved question in economics, dating back at least to David Hume. In the monetary economy described in chapter 4, we show that money isneutral: a one-time, anticipated change in the money supply has no real effects, and nominal prices vary proportionally with the stock of money. Money is not, however,superneutralbecause a change in the rate of growth of money supply, even if anticipated, has real effects by reducing aggregate real balances, real output, and welfare.

    In this chapter we revisit the relationship between changes in money...

  12. 8 Money and Credit
    (pp. 195-228)

    The key distinction between monetary and credit trades is that monetary trades are quid pro quo: goods and services are exchanged simultaneously for currency, and do not involve future obligations. Credit trades, on the contrary, are intertemporal and involve a delayed settlement. In reality, some trades are conducted through credit arrangements, other trades are based on monetary exchange. The coexistence of these different forms of payment raises some interesting questions: Are the frictions that make monetary exchange essential, such as lack of commitment and record keeping, compatible with the existence of credit? How does the presence of monetary exchange affect...

  13. 9 Money, Negotiable Debt, and Settlement
    (pp. 229-250)

    In large value payment systems, such as the Federal Reserve’s Fedwire, participants make and receive payments throughout the day. In an ideal world the payments process would be seamless in the sense that agents receive payments at, or just before, the time they have to make them. In such a world agents will always have sufficient liquidity on hand to make their required payments. In practice, however, the payments process is not so perfectly synchronized; agents may have insufficient liquidity on hand when they wish to, or have to, make a payment. In such circumstances the agent can always wait...

  14. 10 Competing Media of Exchange
    (pp. 251-284)

    Even though fiat money plays a major role in facilitating exchange in practice, there exists a large variety of assets and commodities that can be, and are, used as means of payment. For example, commodities, such as gold and silver, and financial assets, such as demand deposits, checkable mutual funds, and, to some extent, government securities are used for transaction purposes. There is also a plethora of assets (e.g., capital, claims on capital, and stocks) that could be used as means of payment but are not, or only to a limited extent.

    The presence of competing media of exchange raises...

  15. 11 Liquidity, Monetary Policy, and Asset Prices
    (pp. 285-316)

    In frictionless economies the price of an asset depends only on the discounted value of its expected future income flows. In monetary economies assets can in addition be valued for their liquidity properties. These assets are helpful in overcoming the frictions that plague monetary economies, which prevent the use of credit arrangements. An obvious case in point is fiat money. As shown in earlier chapters, if there is limited enforcement and lack of record keeping, fiat money can have a positive value even though its fundamental value, i.e., the discounted sum of its dividends, is zero. Other assets can play...

  16. 12 Liquidity and Trading Frictions
    (pp. 317-338)

    In previous chapters we defined the liquidity of an asset in terms of its ability to function as a medium of exchange in goods markets that are characterized by trading frictions. In this chapter we revisit the notion of liquidity. In contrast to previous chapters, there are no trading frictions associated with the purchase and consumption of goods, and as a result the asset does not play any role as a means of payment. Instead, trading frictions are introduced directly into an asset market best described as an over-the-counter market, with bilateral matches between investors and dealers. Our simple model...

  17. Bibliography
    (pp. 339-356)
  18. Index
    (pp. 357-370)