A search equilibrium approach to monetary theory and policy

This dissertation develops dynamic theoretical frameworks which explicitly incorporate a search-theoretic process of economic exchange into an operational theory of fiat money. The "search equilibrium" approach to trade frictions models the process of economic exchange as a costly activity which requires time and real resources. Thus, such an environment provides a natural role for fiat money in overcoming the classic "double coincidence of wants" problem associated with barter exchange. The dissertation is divided into four essays on the construction of search frameworks for monetary theory and their application to monetary policy. First, the conventional wisdom that inflation causes individuals to optimally incur the costs of shortening the period between transactions is confirmed. This result linking inflation and optimal search effort or "intensity" provides a central theme for the dissertation.; In a general equilibrium context it is established that the search efforts of an individual trader generate a positive external effect on other traders. Thus, monetary equilibria will be inefficient relative to an appropriate criterion for social efficiency. This result suggests that optimal monetary policies in such an environment should consist of actions which reduce this costly external effect and increase aggregate welfare. One possible method to accomplish this task is by manipulating the real money stock. Another is by the imposition of an inflation tax. In particular, it is shown that optimal monetary policies may well involve money growth and inflation which increase individual search effort in locating exchange possibilities. This is in sharp contrast to the traditional view that the optimum quantity of money involves a contraction of the nominal money supply and deflation. The novelty of this result stems from its emphasis on the ability of inflation in stimulating exchange activity.; Finally, the question of optimal monetary policy is extended by investigating the link between inflation, inventory accumulation, and welfare in such search frameworks. It is demonstrated that inflation can indeed have a positive impact on optimal inventory accumulation decisions. Furthermore, this provides an additional channel by which inflation increases the private marginal gains to search activity, thus reducing the search externality and improving welfare.