Why is there Money?

Why is there Money?

Walrasian General Equilibrium Foundations of Monetary Theory

Ross M. Starr

The microeconomic foundation of the theory of money has long represented a puzzle to economic theory. Why is there Money? derives the foundations of monetary theory from advanced price theory in a mathematically precise family of trading post models.

Chapter 1: Why is There Money?

Ross M. Starr

Subjects: economics and finance, history of economic thought, money and banking


This chapter focuses on three centuries of economic literature, reconciling the theory of money with the theory of value. It is challenging 2 on the basis of price theory 2 to discover the function of a medium of exchange; the rationale is transaction cost and differences in transaction cost among goods (commodity money and fiat money). Fiat money is typically an inherently useless fiduciary instrument, yet it trades at a substantial positive price. Further, though no household or firm finds it directly satisfying or productive, money is typically on one side of most transactions in the economy, the most actively traded good. These observations seem to contradict most of the theory of value. The reconciliation consists in valuing fiat money based on its acceptability in payment of taxes (an observation dating back to Smith’s Wealth of Nations, 1776), and in deriving its function as a medium of exchange from its low transaction cost (a notion recurrent in German late 19th-century monetary theory, notably Menger’s ‘Origin of money’, 1892). 1 THEORY OF MONEY AND THEORY OF VALUE One of the oldest issues in economics is to explain the use of money, preferably in elementary terms based on the theory of value. There are contributions extending from Aristotle’s Politics, 350 bce and Smith’s Wealth of Nations to the present. No economic agent can individually decide to monetize; monetary exchange should be the equilibrium outcome of interaction among optimizing agents. Money, like written language, is one of the fundamental discoveries of civilization. The...

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