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The Purchasing Power of Money in an Exchange Economy

Radwanski, Juliusz (2020): The Purchasing Power of Money in an Exchange Economy.

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Abstract

This paper studies the valuation of fiat money in an endowment economy with specialization, costly barter, and imperfect enforcement of promises using a generalized asset-pricing framework of Lucas (1978). The environment features symmetric, competitive, and indefinitely-lived households and allows for a finite number of Markovian state variables. Money is part of a payment system allowing transfers of intrinsically useless net worth between non-negative accounts subject to a fixed time lag. Monetary policy of the issuing authority is designed in terms of sequences of nominal interest rates and transfers of new net worth. Households do not have to use money but optimally demand it from the market for goods at uniquely determined positive value if monetary policy satisfies certain conditions defining a \emph{responsible} policy. The paper offers a general way to construct equilibria under such policies without relying on cash-in-advance constraints or other modeling shortcuts.

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