Monetary Theory


I support the view that a monetary model should derive the existence of a medium of exchange endogenously rather than assume it (Wallace, International Economic Review 2001). Among the available basic models that achieve this goal, I follow those based on Kiyotaki and Wright (Journal of Political Economy 1989).

In The Tax-Foundation Theory of Fiat Money [Economic Theory 50(2), June 2012, 489-497] I model legal tender. Specifically, I model the acceptance of money by the government for tax payments, which is a central (but overlooked) feature of all modern legal tender laws. I show how and when this feature guarantees the money’s circulation. More models and brief discussions of legal and historical issues are in the working paper, which is forthcoming in Randall Wray (ed.), Theories of Money and Banking. An extensive discussion of relevant historical evidence and legal information is in my Monetary History and Law page.

In Money with Partially Directed Search [Journal of Monetary Economics 54(4), May 2007, 979-993], I modify the Kiyotaki-Wright model to include location choices. The predictions of the model regarding both commodity money and fiat money are thus improved. Proofs are in the working paper. An experiment of this model is in Endogenous Market Formation and Monetary Trade: An Experiment , with Gabriele Camera and Avi Weiss [Journal of the European Economic Association, 2019].

In Micro-Foundations of the Keynesian Multiplier I show that the multiplier, the foundation of Keynesian economics, is entirely consistent with strict micro-foundations, if one only uses the right micro-foundations. The Kiyotaki-Wright model offers all the necessary ingredients. Policy responses to shocks are often effective but sometimes might be harmful.