Working Papers
By Year:
Paper #  Author  Title  

10040 
Benjamin Lester Andrew Postlewaite Randall Wright 
“Information, Liquidity, Asset Prices and Monetary Policy”, Second Version  
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. Download Paper


10034 
Allen Head Lucy Qian Liu Guido Menzio Randall Wright 
“Equilibrium Price Dispersion and Rigidity: A New Monetarist Approach”  
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 stickyprice models, money is neutral Download Paper


09040 
Lucy Qian Liu Liang Wang Randall Wright 
"On the Hot Potato Effect of Inflation: Intensive versus Extensive Margins"  
Conventional wisdom is that inflation makes people spend money faster, trying to get rid of it like a 'hot potato', and this is a channel through which inflation affects velocity and welfare. Monetary theory with endogenous search intensity seems ideal for studying this. However, in standard models, inflation is a tax that lowers the surplus from monetary exchange and hence reduces search effort. We replace search intensity with a free entry (participation) decision for buyers  i.e., we focus on the extensive rather than intensive margin  and prove buyers always spend their money faster when inflation increases. We also discuss welfare. Download Paper


08039 
Benjamin Lester Andrew Postlewaite Randall Wright 
"Information, Liquidity and Asset Prices"  
We study economies with multiple assets that are valued both for their return and liquidity. Exchange occurs in decentralized markets with frictions making a medium of exchange essential. Some assets are better suited for this role because they are more liquid  more likely to be accepted in trade  even if they have a lower return. The reason assets are more or less likely to be accepted is modeled using informational frictions, or recognizability. While everyone understands e.g. what currency is and what it is worth, some might be less sure about other claims. In our model, agents who do not recognize assets do not accept them in trade. Recognizability is endogenized by letting agents invest in information, potentially generating multiple equilibria with different liquidity. We discuss implications for asset pricing and for monetary policy. In particular, we show explicitly that what may look like a cashinadvance constraint is not invariant to policy interventions or other changes in the economic environment. Download Paper


08012 
Aleksander Berentsen Guido Menzio Randall Wright 
"Inflation and Unemployment in the Long Run"  
We study the longrun relation between money, measured by inflation or interest rates, and unemployment. We first discuss data, documenting astrong positive relation between the variables at low frequencies. We then develop a framework where both money and unemployment are modeled using explicit microfoundations, integrating and extending recent work in macro and monetary economics, and providing a unified theory to analyze labor and goods markets. We calibrate the model, to ask how monetary factors account quantitatively for lowfrequency labor market behavior. The answer depends on two key parameters: the elasticity of money demand, which translates monetary policy to real balances and profits; and the value of leisure, which affects the transmission from profits to entry and employment. For conservative parameterizations, money accounts for some but not that much of trend unemployment — by one measure, about 1/5 of the increase during the stagflation episode of the 70s can be explained by monetary policy alone. For less conservative but still reasonable parameters, money accounts for almost all lowfrequency movement in unemployment over the last half century. Download Paper


05017 
Damien Gaumont Martin Schindler Randall Wright 
"Alternative Theories of Wage Dispersion"  
We analyze labor market models where the law of one price does not hold; i.e., models with equilibrium wage dispersion. We begin assuming workers are ex ante heterogeneous, and highlight a flaw with this approach: if search is costly, the market shuts down. We then assume workers are homogeneous but matches are ex post heterogeneous. This model is robust to search costs, and delivers equilibria equilibrium wage dispersion. However, we prove the law of two prices holds: generically we cannot get more than two wages. We explore several other models, including one combining ex ante and ex post heterogeneity; this model is robust, and can deliver more than twopoint wage distributions. Download Paper


03032 
Guillaume Rocheteau Randall Wright 
"Inflation and Welfare in Models with Trading Frictions"  
We study the effects of inflation in models with various trading frictions. The framework is related to recent searchbased monetary theory, in that trade takes place periodically in centralized and decentralized markets, but we consider three alternative mechanisms for price formation: bargaining, price taking, and posting. Both the value of money per transaction and market composition are endogenous, allowing us to characterize intensive and extensive margin effects. In the calibrated model, under posting the cost of inflation is similar to previous estimates, around 1% of consumption. Under bargaining, it is considerably bigger, between 3% and 5%. Under price taking, the cost of inflation depends on parameters, but tends to be between the bargaining and posting models. In some cases, moderate inflation may increase output or welfare. Download Paper


03031 
Guillaume Rocheteau Randall Wright 
"Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium"  
We compare three pricing mechanisms for monetary economies: bargaining (search equilibrium); price taking (competitive equilibrium); and price posting (competitive search equilibrium). We do this in a framework that, in addition to considering different mechanisms, extends existing work on the microfoundations of money by allowing a general matching technology and endogenous entry. We study how the nature of equilibrium and effects of policy depend on the mechanism. Under bargaining, trades and entry are both inefficient, and inflation implies a firstorder welfare loss. Under price taking, the Friedman rule solves the first inefficiency but not the second, and inflation can actually improve welfare. Under posting, the Friedman rule implies first best, and inflation reduces welfare but the effect is second order. Download Paper


03030 
Kenneth Burdett Ricardo Lagos Randall Wright 
"An OntheJob Search Model of Crime, Inequality, and Unemployment"  
We extend simple searchtheoretic models of crime, unemployment and inequality to incorporate onthejob search. This is valuable because, lthough the simple models can be used to illustrate some important points concerning the economics of crime, onthejob search models are more relevant empirically as well as more interesting in terms of the types of equilibria they generate. We characterize crime decisions, unemployment, and the equilibrium wage distribution. We use quantitative methods to illustrate key results, including a multiplicity of equilibria with different unemployment and crime rates, and to discuss the effects of changes in labor market and anticrime policies. Download Paper


03029 
Kenneth Burdett Ricardo Lagos Randall Wright 
"Crime, Inequality, and Unemployment", Second Version: September 2003  
There is much discussion of the relationships between crime, inequality, and unemployment. We construct a model where all three are endogenous. We find that introducing crime into otherwise standard models of labor markets has several interesting implications. For example, it can lead to wage inequality among homogeneous workers. Also, it can generate multiple equilibria in natural but previously unexplored ways; hence two identical neighborhoods can end up with different levels of crime, inequality, and unemployment. We discuss the effects of anticrime policies like changing jail sentences, as well as more traditional labor market policies like changing unemployment insurance. Download Paper


03028 
S. Boragan Aruoba Randall Wright 
"Search, Money and Capital: A Neoclassical Dichotomy", Second Version: September 3, 2003  
Recent work has reduced the gap between searchbased monetary theory and mainstream macroeconomics by incorporating into the search mode some centralized markets as well as some decentralized markets where money is essential. This paper takes a further step towards this integration by introducing labor, capital and neoclassical firms. The resulting framework nests the searchtheoretic monetary model and a standard neoclassical growth model as special cases. Perhaps surprisingly, it also exhibits a dichotomy: one can determine the equilibrium path for the value of money independently of the paths of consumption, investment and employment in the centralized market. Download Paper


02043 
Andrei Shevchenko Randall Wright 
"A Simple Search Model of Money with Heterogeneous Agents and Partial Acceptability"  
Simple search models have equilibria where some agents accept money and others do not. We argue such equilibria should not be taken seriously  which is unfortunate if one wants a model with partial acceptability. We introduce heterogeneous agents and show partial acceptability arises naturally. There can be multiple equilibria with different degrees of acceptability. Given the type of heterogeneity we allow, the model is still simple: equilibria reduce to fixed points in [0,1]. We show that with other forms of heterogeneity, equilibria are generally fixed points in set space, and there exists no method to reduce this to a problem in R1. Download Paper


02042 
Ricardo Lagos Randall Wright 
"Dynamics, Cycles and Sunspot Equilibria in 'Genuinely Dynamic, Fundamentally Disaggregative' Models of Money"  
This paper pursues a line of Cass and Shell, who advocate monetary models that are "genuinely dynamic and fundamentally disaggregative" and incorporate "diversity among households and variety among commodities." Recent searchtheoretic models fit this description. We show that, like overlapping generations models, search models generate interesting dynamic equilibria, including cycles, chaos, and sunspot equilibria. This helps us understand how alternative models are related, and lends support to the notion that endogenous dynamics and uncertainty matter, perhaps especially in monetary economies. We also suggest such equilibria in search models may be more empirically relevant than in some other models. Download Paper


02041 
Richard Rogerson Randall Wright 
"SearchTheoretic Models of the Labor Market: A Survey"  
This essay provides a survey of various models that use search theory to analyze labor markets. By search theory, we mean a framework in which trading frictions are modeled explicitly. Search models generate unemployment as an equilibrium outcome, and also allow us to discuss various ways in which wages and other prices are determined by agents in the model. We present the basic singleagent search problem in a variety of different forms. We describe the endogenous determination of the wage distribution. We present some simple equilibrium models of the labor market and discuss some machinery that is common in such models, including the notion of a matching technology, as well as basic bargaining theory. We present a version that is designed explicitly to analyze job creation and destruction. Download Paper


02040 
Ricardo Lagos Randall Wright 
"A Unified Framework for Monetary Theory and Policy Analysis"  
Searchtheoretic 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 illsuited for discussing some policy questions, especially those concerning changes in the money supply. Hence most policy analysis uses reducedform 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. Download Paper


02039 
Elisabeth Curtis Randall Wright 
"Price Setting, Price Dispersion, and the Value of Money or, The Law of Two Prices"  
We study models that combine search, monetary exchange, price posting by sellers, and buyers with preferences that differ across random meetings  say, because sellers in different meetings produce different varieties of the same good. We show how these features interact to influence the price level (i.e., the value of money) and price dispersion. First, priceposting equilibria exist with valued fiat currency, which is not true in the standard model. Second, although both are possible, price dispersion is more common than a single price. Third, perhaps surprisingly, we prove generically there cannot be more than two prices in equilibrium. Download Paper


02038 
Kenneth Burdett Ricardo Lagos Randall Wright 
"Crime, Inequality, and Unemployment  
There has been much discussion of the relationships between crime, inequality and unemployment. We construct a model where all three are endogenous. Introducing crime into otherwise standard models affects the labor market in several interesting ways. For example, we show how the crime rate affects the unemployment rate and viceversa; how the possibility of criminal activity can lead to wage inequality among homogeneous workers; and how the possibility of crime can generate multiple equilibria in natural but previously unexplored ways. In particular, two fundamentally identical neighborhoods may easily end up with different levels of unemployment, inequality, and crime. The model can be used to study the equilibrium effects of anticrime policies, such as changes in apprehension rates or jail sentences, as well as more traditional labor market policies such as unemployment insurance. Download Paper


02037 
Kenneth Burdett Ryoichi Imai Randall Wright 
"Unstable Relationships"  
We analyze models where agents search for partners to form relationships (employment, marriage, etc.), and may continue searching for different partners while matched. Matched agents are less inclined to search if their match yields more utility and if it is more stable. If one partner searches, the relationship is less stable, so the other is more inclined to search, potentially making instability a selffulfilling prophecy. We show this can generate a multiplicity  indeed, a continuum  of steady state equilibria. In any equilibrium there tends to be too much turnover, unemployment, and inequality compared to the efficient outcome. A calibrated version of the model explains 1/2 to 2/3 of reported jobtojob transitions. Download Paper


02036 
S. Boragan Aruoba Randall Wright 
"Search, Money and Capital: A Neoclassical Dichotomy"  
Recent work has reduced the gap between searchbased monetary theory and mainstream macroeconomics by incorporating into the search model some centralized markets as well as some decentralized markets where money is essential. This paper takes a further step towards this integration by introducing labor, capital and neoclassical firms. The resulting framework nests the searchtheoretic monetary model and a standard neoclassical growth model as special cases. Perhaps surprisingly, it also exhibits a dichotomy: one can determine the equilibrium path for the value of money independently of the paths of consumption, investment and employment in the centralized market. Download Paper


99003 
Kenneth Burdett Alberto Trejos Randall Wright 
"Cigarette Money"  
We study the circumstances under which commodities emerge endogenously as media of exchange  the way cigarettes apparently did, for example, in POW camps  both when there is fiat money available and when there is not. We characterize how specialization, the degree of trading frictions, intrinsic properties of commodities, and the amount of fiat money available determine whether a commodity serves as money and its exchange value. In some equilibria, the exchange value of commodity money is pinned down by its consumption value; in others, it is not. The value of fiat money mayor may not be pinned down by that of commodity money, depending on circumstances. We also allow commodities to come in heterogeneous qualities and discuss the implications for Gresham's Law. Download Paper


99002 
Aleksander Berentsen Miguel Molico Randall Wright 
"Indivisibilities, Lotteries, and Monetary Exchange"  
We introduce lotteries  that is, randomized trading  into searchtheoretic models of monetary exchange. In the model with indivisible goods and fiat money, we show that in any monetary equilibrium goods change hands with probability 1 and money changes hands with probability 7 where 7 < 1 iff the buyer has sufficient bargaining power. In the model with divisible goods, a nonrandom quantity of goods q changes hands with probability 1 and, again, money changes hands with probability 7 where 7 < 1 iff the buyer has sufficient bargaining power. Hence, the implicit assumption made in the previous literature that lotteries are ruled out is restrictive. Moreover , q may be less than but can never exceed the efficient quantity ( a result that cannot be shown without lotteries). We also consider the implications of lotteries for models with direct barter or commodity money. If commodity money has sufficient intrinsic value, we show the equilibrium quantity q is necessarily efficient ( another result that cannot be shown without lotteries). Download Paper


97016 
Richard Rogerson Peter Rupert Randall Wright 
"Homework in Labor Economics: Household Production and Intertemporal Substitution"  
We argue that estimates of intertemporal substitution elasticities obtained from standard life cycle models are subject to a downward bias because they neglect changes in work done at home over the life cycle. We extend the standard life cycle model to include home production and estimate it using data from three time use surveys. We find that the downward bias is large. Download Paper


97015 
Alberto Trejos Randall Wright 
"Toward a Theory of International Currency: A Step Further"  
We generalize the twocountry, twocurrency, searchbased monetary model of Matsuyama, Kiyotaki and Matsui to resolve two "shortcomings" in their approach. First, we endogenize prices and exchange rates. Second, we discuss some policy considerations. We use the model to address several questions related to the determination of the realms of circulation and relative values of different monies. Download Paper


97014 
Yiting Li Randall Wright 
"Policy Analysis in SearchBased Models of Money"  
The objective of this paper is to study the effects of government policies described as a searchtheoretic (or random matching) model of money. A search model is the right tool for the job because it generates an endogenous transactions pattern that allows one to determine in equilibrium which objects are accepted in which trades, and at what relative prices. Our framework willi allow one to analyze the effects of government transactions policies on these outcomes, and to make precise how these effects depend on things like the size and influence of the government in the economy. Download Paper


97009 
Melvyn Coles Randall Wright 
"A Dynamic Equilibrium Model of Search, Bargaining, and Money"  
We characterize dynamic (not just steady state) equilibria in a searchtheoretic model of fiat money, where buyers and sellers, upon meeting, enter bargaining games to determine prices. Equilibrium in the bargaining game is approximated in terms of a tractable dynamical system, in much the same way that the Nash solution approximates equilibrium in bargaining games in stationary environments. The model with our dynamic bargaining solution can generate outcomes (such as limit cycles) that never arise in the same model if one imposes a myopic bargaining solution, as has been done in the past. Download Paper


97007 
Francois R. Velde Warren E. Weber Randall Wright 
"A Model of Commodity Money, With Application to Gresham's Law and the Debasement Puzzle"  
We develop a model of commodity money and use it to analyze the following two questions motivated by issues in monetary history: What are the conditions under which Gresham's Law holds? And, what are the mechanics of a debasement (lowering the metallic content of coins)? The model contains light and heavy coins, imperfect information, and prices determined via bilateral bargaining. There are equilibria with neither, both, or only one type of coin in circulation. When both circulate, coins may trade by weight or by tale. We discuss the extent to which Grsham's Law holds in the various cases. Following a debasement, the quantty of reminting depends ont the incentives offered by the sovereign. Equilibria exist with positive seigniorage and a mixtdure of old and new coins in circulation Download Paper
