A Search Theory of Money and Commerce with Neoclassical Production

Abstract

This paper advances a highly tractable model with search theoretic foundations for money and neoclassical growth. In the model, manufacturing and commerce are distinct and separate activities. In manufacturing, goods are efficiently produced combining capital and labor. In commerce, goods are exchanged in bilateral meetings. The model is applied to study the effects of inflation on capital accumulation and welfare. With realistic parameters, inflation as large negative effects on welfare even though it raises capital and output. In contrast, with cash-in-advance, a device informally motivated with bilateral trading, inflation depresses capital and output and has a negligible effect on welfare.

Keywords: Search, money, commerce, inflation, neoclassical production, capital accumulation, optimum quantity of money

JEL Classification: E40, E52, E13