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The value of money in a dynamic equilibrium model

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This paper studies the pricing of money in an infinite-horizon economy with heterogeneous agents, incomplete financial markets and arbitrary borrowing restrictions. Purchases of the consumption good are subject to a cash-in-advance constraint. Under general conditions I show that the price of money is equal to its fundamental value, where this value is defined over all state-price processes that are compatible with the existence of no-arbitrage opportunities. This equality implies that the cash-in-advance constraint is binding infinitely often for all agents in the economy. The analysis highlights certain differences in the determination of the price of money with respect to models with money in the utility function that bear on the optimal implementation of economic policies.

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Correspondence to Manuel S. Santos.

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Received: 23 October 2003, Revised: 26 August 2004

JEL Classification Numbers:

D52, E44, G12.

M.S. Santos: This paper is an outgrowth of an earlier collaboration with Michael Woodford. I have also benefitted from various discussions with Eduardo Gimenez, Alejandro Hernandez, and Miguel Iraola. Some very useful comments by an anonymous referee are greatly appreciated.

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Santos, M.S. The value of money in a dynamic equilibrium model. Economic Theory 27, 39–58 (2006).

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