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The B.E. Journal of Macroeconomics

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Ed. by Abraham, Arpad / Carceles-Poveda , Eva / Debortoli, Davide / Kambourov, Gueorgui / Lambertini, Luisa / Pavoni, Nicola / Ruhl, Kim / Nimark, Kristoffer / Wang, Pengfei

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Patterns of Exchange, Fiat Money, and Coordination

Irasema Alonso1

1University of Rochester,

Citation Information: Advances in Macroeconomics. Volume 1, Issue 2, ISSN (Online) 1534-6013, DOI: 10.2202/1534-6013.1026, September 2001

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Many argue that the intrinsic uselessness of fiat money makes ``coordination'' an essential part of monetary theory: consumers could all equally well coordinate on believing that fiat money has no value. The coordination view suggests, however, that many transactions patterns are in fact possible as economic outcomes. Indeed, we do seem to observe different patterns of exchange at different times and in different places, and the relative importance of money is probably not a universal constant. The main goal of this paper is to develop a simple model of money's role as a medium of exchange when multiple transaction patterns are possible. The coordination view is conveniently analyzed in a dynamic version of Shubik's game-theoretic trading post economy. This economy allows a role for fiat money, and fiat money can coexist with barter in exchange. There are multiple decentralized equilibria, and one of these coincides with the equilibrium of a cash-in-advance economy: the model can be viewed as a generalization of the cash-in-advance framework. Other equilibria use both money and other, intrinsically valuable, objects as media of exchange. One implication of the coordination view is that the effects of monetary policy in general depend on the equilibrium transactions pattern. The paper illustrates this point by showing how estimates of the welfare costs of inflation may be biased depending on the econometrician's beliefs about the transactions patterns.

Keywords: Trading post; fiat money; barter; welfare costs of inflation

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Irasema Alonso
Review of Economic Dynamics, 2004, Volume 7, Number 3, Page 687

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