We construct a model where money and credit are alternative payment instruments, use it to analyze sluggish nominal prices, and confront the data. Equilibria entail price dispersion, where sellers set nominal terms that they may keep fixed when aggregate conditions change. Buyers use cash and credit, with the former (latter) subject to inflation (transaction costs). We provide strong analytic results and exact solutions for money demand. Calibrated versions match price-change data well, with realistic durations, large average changes, many small and negative changes, a decreasing hazard, and behavior that changes with inflation, while staying consistent with macro and micro data on money and credit. Policy implications are discussed.

What determines which assets are used in transactions? We develop a framework where the extent to which assets are recognizable determines the extent to which they are acceptable in exchange - i.e., their liquidity. We analyze the effects of monetary policy on asset markets. Recognizability and liquidity are endogenized by allowing agents to invest in information. There can be multiple equilibria with different transaction patterns. These transaction patterns are not invariant to policy. We show small changes in information that may generate large responses in prices, allocations and welfare. We also discuss issues in international economics, including exchange rates and dollarization.

We study how perfectly anticipated inflation affects allocations and prices in a new-monetarist model with a home-production sector. Inflation taxes market production but not home production, since cash is essential for some market transactions but is not necessary to enjoy home-produced goods. In response to inflation, households substitute activity from the taxed sector (market) to the untaxed sector (home). Since housing is an input to home production, people accumulate housing in response to inflation. If housing is not perfectly elastically supplied, due to the presence of a fixed factor such as land in the production of new housing, the price of housing rises. We document a strong positive relationship between house values and consumer price inflation present in post-war U.S. data and investigate the degree to which our model can replicate this and other facts.

The 2010 Summer Workshop on Money, Banking, Payments and Finance met at the Federal Reserve Bank of Chicago this summer, for the second year. The following document summarizes and ties together the papers presented.

Why do some sellers set prices in nominal terms that do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption. Here it is a result. We use search theory, with two consequences: prices are set in dollars since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When money increases, some sellers keep prices constant, earning less per unit but making it up on volume, so profit is unaffected. The model is consistent with the micro data. But, in contrast with other sticky-price models, money is neutral.

We study the long-run relation between money (inflation or interest rates) and unemployment. We document positive relationships between these variables at low frequencies. We develop a framework where money and unemployment are modeled using explicit microfoundations, providing a unified theory to analyze labor and goods markets. We calibrate the model and ask how monetary factors account for labor market behavior. We can account for a sizable fraction of the increase in unemployment rates during the 1970s. We show how it matters whether one uses monetary theory based on the search-and-bargaining approach or on an ad hoc cash-in-advance constraint. ______________________ * Berentsen: Bernoulli Center for Economics, Faculty of Business and Economics, University of Basel, Peter-Merian-Weg 6, Postfach, CH-4002 Basel, Switzerland (email aleksander.berentsen@unibas.ch). Menzio: Department of Economics, University of Pennsylvania, 3718 Locust Walk, Philadelphia PA 19104 (email gmenzio@econ.upenn. edu). Wright: Department of Finance and Department of Economics, University of Wisconsin Madison, 975 University Ave., Madison, WI 53706, and Federal Reserve Bank of Minneapolis, 90 Hennepin Ave., Minneapolis, MN 55401 (email rwright@bus. wisc.edu). For comments on earlier versions of this paper we thank Kenneth Burdett, Marcus Hagedorn, Allen Head, Nobuhiro Kiyotaki, Robert Lucas, Iourii Manovskii, Dale Mortensen, and participants in seminars or conferences at Yale, Penn, New York University, Simon Fraser University, University of British Columbia, Queens, Vienna, Rome, Paris (Nanterre), Glasgow, Edinburgh, Essex, Kiel, Konstanz, Dortmund, Chicago, Northwestern, Maryland, Notre Dame, Arhuus, Amsterdam, TexasAustin, the Cleveland, Minneapolis, New York and Chicago Feds, the Central Banks of Canada, Portugal, Australia, Switzerland and Colombia, the European Central Bank, the NBER, the Canadian Macro Study Group, the Society for Economic Dynamics, Verein für Socialpolitik Theoretischer Ausschuss, and the Econometric Society Winter Meetings. Berentsen acknowledges SNF support (grant #1000014118306). Wright acknowledges NSF support (grant #0350900). The usual disclaimer applies.

The authors study banking using the tools of mechanism design, without a priori assumptions about what banks are, who they are, or what they do. Given preferences, technologies, and certain frictions - including limited commitment and imperfect monitoring - they describe the set of incentive feasible allocations and interpret the outcomes in terms of institutions that resemble banks. The bankers in the authors' model endogenously accept deposits, and their liabilities help others in making payments. This activity is essential: if it were ruled out the set of feasible allocations would be inferior. The authors discuss how many and which agents play the role of bankers. For example, they show agents who are more connected to the market are better suited for this role since they have more to lose by reneging on obligations. The authors discuss some banking history and compare it with the predictions of their theory.

This paper summarizes the papers that were presented at the Liquidity in Frictional Markets conference in November 2008. The papers, which looked at markets for assets as diverse as houses, bank loans, and electronic funds transfer, all explored that amorphous concept called “liquidity” and how its presence — or absence — affects the economy. Papers presented at the conference and summarized here were: Asset Prices, Liquidity, and Monetary Policy in an Exchange Economy (R. Lagos); Banks, Liquidity Insurance, and Interest on Reserves in a Matching Model of Money (V. Bencivenga, G. Camera); Counterfeiting as Private Money in Mechanism Design (R. Cavalcanti, E. Nosal); Elastic Money, Inflation, and Interest Rate Policy (A. Head, J. Qiu); Information, Liquidity and Asset Prices (B. Lester, A. Postlewaite, R. Wright); Liquidity and Selection in Asset Markets with Search Friction (Y. Kim); Liquidity Provision in Capacity Constrained Markets (P. Weill); Money, Bargaining, and Risk Sharing (N. Jacquet, S. Tan); Precautionary Reserves and the Interbank Market (A. Ashcraft, J. McAndrews, D. Skeie); Price-Level Targeting and Stabilization Policy (A. Berentsen, C. Waller); Systemic Risk and Liquidity in Payment Systems (G. Afonso and H. Shin); Trading Frictions and House Price Dynamics (A Caplin, J. Leahy); Uncertainty, Inflation, and Welfare (J. Chiu, M. Molico); When Banks Lend for Too Long (C. Chamley, C. Rochon).

We study the effects of money (anticipated inflation) on capital formation. Previous papers on this topic adopt reduced-form approaches, putting money in the utility function or imposing cash in advance, but use otherwise frictionless models. We follow a literature that is more explicit about the frictions making money essential. This introduces several new elements, including a two-sector structure with centralized and decentralized markets, stochastic trading opportunities, and bargaining. We show how these elements matter qualitatively and quantitatively. Our numerical results differ from findings in the reduced-form literature. The analysis reduces the previously large gap between mainstream macro and monetary theory.

This Policy Discussion Paper summarizes the papers presented at the 2006 Summer Workshop on Money, Banking, and Payments. Every summer since 2002, some of the best researchers in the areas of theory, policy, and quantitative analysis relating to money, banking, and payments systems have met in Cleveland to discuss their latest work. The papers presented at the 2006 workshop cover a vast spectrum of issues and use a wide variety of methods. Still, there is an underlying theme, which is an effort to enhance our understanding of monetary economics, broadly defined, and to uncover new ways to think about important substantive issues. Hopefully, this helps not only theoretical monetary economists, but also economists such as central bankers with a more practical policy-oriented view.

We provide a summary and an overview of the papers presented at the Federal Reserve Bank of Cleveland’s 2004 Workshop on Money, Banking, and Payments, held during the weeks of August 3-7 and August 23-27, 2004.

This PDP summarizes the papers presented at the 2005 Summer Workshop on Money, Banking, and Payments at the Cleveland Fed. Papers covered a wide variety of topics in monetary theory and policy, banking, and payments systems research. Topics ranged from optimal monetary policy, optimal bank contracts, the private supply of money, the coexistence of credit, money, and capital, the design of payment systems, and international currencies. Effort was made to calibrate models and bring them closer to the data. These contributions illustrate the progress made in the field of monetary theory.

Search models with wage posting and match-specific heterogeneity generate wage dispersion. Given K values for the match-specific variable, it is known that there are K reservation wages that could be posted, but generically never more than two actually are posted in equilibrium. What is unknown is when we get two wages, and which of the reservation wages are actually posted. For an example with K = 3, we show equilibrium is unique, may have one wage or two, and when there are two, the equilibrium can display any combination of posted reservation wages, depending on parameters. We also show how wages, profits and unemployment depend on productivity.

We analyze labor market models where the law of one price fails – i.e., models with equilibrium wage dispersion. We begin considering ex ante heterogeneous workers, but highlight a problem with this approach: if search is costly the market shuts down. We then assume homogeneous workers but ex post heterogeneous matches. This model is robust to search costs, and delivers equilibrium wage dispersion. However, we prove that the law of two prices holds: equilibrium implies at most two wages. We explore other models, including one combining ex ante and ex post heterogeneity which is robust and delivers more realistic wage dispersion.

Search-theoretic models of monetary exchange are based on explicit descriptions of the frictions that make money essential. However, tractable versions usually have strong assumptions that make them ill-suited for discussing some policy questions, especially those concerning changes in the money supply. Hence most policy analysis uses reduced-form models. We propose a framework that attempts to bridge this gap: it is based explicitly on microeconomic frictions, but allows for interesting macroeconomic policy analyses. At the same time, the model is analytically tractable and amenable to quantitative analysis.

We compare three market structures for monetary economies: bargaining (search equilibrium); price taking (competitive equilibrium); and price posting (competitive search equilibrium). We also extend work on the microfoundations of money by allowing a general matching technology and entry. We study how equilibrium and the effects of policy depend on market structure. Under bargaining, trade and entry are both inefficient, and inflation implies first-order welfare losses. Under price taking, the Friedman rule solves the first inefficiency but not the second, and inflation may actually improve welfare. Under posting, the Friedman rule yields the first best, and inflation implies second-order welfare losses.