Why is there Money?
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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.
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Chapter 13: Alternative Models

Ross M. Starr


Monetary general equilibrium models include sequence economy models, overlapping generations models, and random matching models. Partial equilibrium models include models of the demand for money. Sequence economy models and money demand models emphasize the role of transaction costs, as does the trading post model. The general equilibrium models emphasize the sequential character of transactions 2 and hence the need for a carrier of value between transactions. 1 SEQUENCE ECONOMY The approach closest in Arrow2Debreu style general equilibrium theory to a model of money occurs in a sequence economy model. This model modifies the notion that all trade for all time takes place in a grand single trade. Instead, markets reopen over time at each of a sequence of dates. Then there is a budget constraint at each market date. This framework generates demand for a carrier of value between market dates and hence a monetary instrument. Essays in this genre include Hahn (1971, 1973), Starrett (1973), Kurz (1974), Heller (1974), and Heller and Starr (1976). The treatment typically includes transaction costs so that bid and ask prices (or shadow bid and ask prices when the transaction costs are internalized to the transactors) may differ. Several principal results then follow. There is a demand for ‘money’ or a commodity money carrier of value across time. In the case of set-up (nonconvex) transaction costs, the transaction cost structure may lead to inventory holding, both of real goods and of money. The multiplicity of budget constraints may require (otherwise redundant) transactions to fulfill...

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