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Endogenous Liquidity and Currency Unions

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  • Peterson Brian

    (Indiana University)

Abstract

This paper extends existing search-theoretic models of monetary exchange, and uses the framework to explore the following applications. First, I show how to endogenize the supply of liquidity in a simple (one-country) model where commodity money can be created, say through mining and minting, and also consumed, say melted or shipped abroad for imported goods. Second, I develop an explicit multi-country version of the model that determines how liquidity is allocated across economies that share the same currency, such as the euro-zone. The implications of the analysis are similar on many dimensions to more traditional theories, such as Hume's price-specie flow theory, or Mundell's monetary theory of the current account. However, in the current framework the role for money has explicit microfoundations based on frictions in the trading process. At the same time, as compared to existing search-based models in monetary economics, especially those used to address international issues, the current framework is much more natural and also much more tractable.

Suggested Citation

  • Peterson Brian, 2009. "Endogenous Liquidity and Currency Unions," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-34, March.
    • Handle: RePEc:bpj:bejmac:v:9:y:2009:i:1:n:6
    DOI: 10.2202/1935-1690.1634
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    References listed on IDEAS

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    1. Head, Allen & Shi, Shouyong, 2003. "A fundamental theory of exchange rates and direct currency trades," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1555-1591, October.
    2. François R. Velde & Warren E. Weber & Randall Wright, 1999. "A Model of Commodity Money, with Applications to Gresham's Law and the Debasement Puzzle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 291-323, January.
    3. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
    4. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-141, February.
    5. Kiminori Matsuyama & Nobuhiro Kiyotaki & Akihiko Matsui, 1993. "Toward a Theory of International Currency," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(2), pages 283-307.
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    Cited by:

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    2. Martin, Antoine & Schreft, Stacey L., 2006. "Currency competition: A partial vindication of Hayek," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 2085-2111, November.

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