| Title |
Date |
Publication |
Author(s) |
Type |
| A Conference on Liquidity in Frictional Markets
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May, 2009 |
Federal Reserve Bank of Cleveland, Policy Discussion Paper, no. 26 |
Guillaume Rocheteau; Joseph G Haubrich; Pierre-Olivier Weill; Randall Wright; |
Policy Discussion Papers |
| Abstract: This Policy Discussion Paper summarizes the papers that were presented at the Liquidity in Frictional Markets conference in November 2008. The papers, which looked at markets for assets as diverse as houses, bank loans, and electronic funds transfer, all explored that amorphous concept called “liquidity” and how its presence—or absence—affects the economy.
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| Information and Liquidity: A Discussion
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January, 2009 |
Federal Reserve Bank of Cleveland, Working Paper no.0902 |
Guillaume Rocheteau; |
Working Papers |
| Abstract: I extend and discuss the model of asset liquidity by Lester, Postlewaite, and Wright (2007, 2008). I consider a model with decentralized trades in which claims on a real and divisible asset serve as means of payment. A recognizability problem is introduced by assuming that the claims on the asset can be counterfeited at a positive cost. This formalization nests the models by Lagos and Rocheteau (2008) and Geromichalos, Licari, and Suarez-Lledo (2007), in which there is no recognizability problem, and Lester, Postlewaite, and Wright (2007), in which counterfeits can be produced at no cost. Even though no counterfeiting occurs in equilibrium, the recognizability problem affects the composition of trades: Buyers consume less and spend a lower fraction of their asset holdings in matches where sellers are uninformed. Both the asset’s price and its liquidity (as measured by its transaction velocity) depend on the recognizability of the asset. The asset is more liquid and its return is lower if either the sellers’ ability to recognize counterfeits or the cost of producing counterfeits increases.
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| A Monetary Approach to Asset Liquidity
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January, 2009 |
Federal Reserve Bank of Cleveland, Working Paper no. 0901 |
Guillaume Rocheteau; |
Working Papers |
| Abstract: This paper offers a monetary theory of asset liquidity—one that emphasizes the role of assets in payment arrangements—and it explores the implications of the theory for the relationship between assets’ intrinsic characteristics and liquidity, and the effects of monetary policy on asset prices and welfare. The environment is a random-matching economy where fiat money coexists with a real asset, and no restrictions are imposed on payment arrangements. The liquidity of the real asset is endogenized by introducing an informational asymmetry in regard to its fundamental value. The model delivers the following insights. A monetary equilibrium exists irrespective of the per capita supply of the real asset, provided that inflation is not too high. The illiquidity premium paid to the real asset tends to increase as the asset becomes riskier and more abundant. Monetary policy affects the real asset’s return when its quantity is not too large and inflation is in some intermediate range. The model predicts a negative relationship between inflation and the real asset’s expected return.
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| On the Threat of Counterfeiting
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November, 2008 |
Federal Reserve Bank of Cleveland, Working Paper no. 0809 |
Guillaume Rocheteau; Yiting Li; |
Working Papers |
| Abstract: We study counterfeiting of currency in a search–theoretic model of monetary exchange. In contrast to Nosal and Wallace (2007), we establish that counterfeiting does not pose a threat to the existence of a monetary equilibrium; i.e., a monetary equilibrium exists irrespective of the cost of producing counterfeits, or the ease with which genuine money can be authenticated. However, the possibility to counterfeit ?at money can affect its value, velocity, output and welfare, even if no counterfeiting occurs in equilibrium. We provide two extensions of the model under which the threat of counterfeiting can materialize: counterfeits can circulate across periods, and sellers set terms of trades in some matches. Policies that make the currency more costly to counterfeit or easier to recognize raise the value of money and society’s welfare, but the latter policy does not always decrease counterfeiting.
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| Liquidity in Asset Markets with Search Frictions
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May, 2008 |
Federal Reserve Bank of Cleveland, Working Paper no. 0804 |
Guillaume Rocheteau; Ricardo Lagos; |
Working Papers |
| Abstract: We develop a search-theoretic model of financial intermediation and use it to study how trading frictions affect the distribution of asset holdings, asset prices, efficiency, and standard measures of liquidity. A distinctive feature of our theory is that it allows for unrestricted asset holdings, so market participants can accommodate trading frictions by adjusting their asset positions. We show that these individual responses of asset demands constitute a fundamental feature of illiquid markets: they are a key determinant of bid-ask spreads, trade volume, and trading delays—all the dimensions of market liquidity that search-based theories seek to explain.
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| Money and Competing Assets under Private Information
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April, 2008 |
Federal Reserve Bank of Cleveland, Working Paper no. 0802 |
Guillaume Rocheteau; |
Working Papers |
| Abstract: I study random-matching economies where at money coexists with real assets, and no restrictions are imposed on payment arrangements. I emphasize informational asymmetries about asset fundamentals to explain the partial illiquidity of real assets and the usefulness of at money. The liquidity of the real asset, as measured by its transaction velocity, is shown to depend on the discrepancy of its dividend across states as well as policy. I analyze how monetary policy affects payment arrangements, asset prices, and welfare.
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| Positive and Normative Effects of a Minimum Wage
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January, 2008 |
Federal Reserve Bank of Cleveland, Working Paper no. 0801 |
Guillaume Rocheteau; Murat Tasci; |
Working Papers |
| Abstract: We review the positive and normative effects of a minimum wage in various versions of a search-theoretic model of the labor market.
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| Coordination Failures in the Labor Market
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November, 2007 |
Federal Reserve Bank of Cleveland, Economic Commentary |
Guillaume Rocheteau; Murat Tasci; |
Economic Commentary |
| Abstract: Can two countries, or two different states, with similar technologies, resources, and policies exhibit differences in labor market performance? In contrast to a commonly held view, the answer is yes under some conditions that we review in this Commentary. If these conditions are satisfied, the unemployment rate and the production of an economy can fluctuate even in the absence of shocks. Moreover, government intervention can be useful provided that it coordinates the economy on the preferred outcome.
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| Crime and the Labor Market: A Search Model With Optimal Contracts
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October, 2007 |
Federal Reserve Bank of Cleveland, Working Paper no. 0715 |
Guillaume Rocheteau; Bryan Engelhardt; Peter C Rupert; |
Working Papers |
| Abstract: This paper extends the Pissarides (2000) model of the labor market to include crime and punishment `a la Becker (1968). All workers, irrespective of their labor force status can commit crimes and the employment contract is determined optimally. The model is used to study, analytically and quantitatively, the effects of various labor market and crime policies. For instance, a more generous unemployment insurance system reduces the crime rate of the unemployed but its effect on the crime rate of the employed depends on job duration and jail sentences. When the model is calibrated to U.S. data, the overall effect on crime is positive but quantitatively small. Wage subsidies reduce unemployment and crime rates of employed and unemployed workers, and improve society's welfare. Hiring subsidies reduce unemployment but they can raise the crime rate of employed workers. Crime policies (police technology and jail sentences) affect crime rates signifi cantly but have only negligible effects on the labor market.
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| Crashes and Recoveries in Illiquid Markets
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August, 2007 |
Federal Reserve Bank of Cleveland, Working Paper no. 0708 |
Guillaume Rocheteau; Ricardo Lagos; Pierre-Olivier Weill; |
Working Papers |
| Abstract: We study the dynamics of liquidity provision by dealers during an asset market crash, described as a temporary negative shock to investors' aggregate asset demand. We consider a class of dynamic market settings where dealers can trade continuously with each other, while trading between dealers and investors is subject to delays and involves bargaining. We derive conditions on fundamentals, such as preferences, market structure and the characteristics of the market crash (e.g., severity, persistence) under which dealers provide liquidity to investors following the crash. We also characterize the conditions under which dealers' incentives to provide liquidity are consistent with market efficiency.
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| Liquidity in Asset Markets with Search Frictions
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June, 2007 |
Federal Reserve Bank of Cleveland, Working Paper no. 0706 |
Guillaume Rocheteau; Ricardo Lagos; |
Working Papers |
| Abstract: We study how trading frictions in asset markets affect the distribution of asset holdings, asset prices, efficiency, and standard measures of liquidity. To this end, we analyze the equilibrium and optimal allocations of a search-theoretic model of financial intermediation similar to Duffie, Gârleanu and Pedersen (2005). In contrast with the existing literature, the model we develop imposes no restrictions on asset holdings, so traders can accommodate frictions by varying their trading needs through changes in their asset positions. We find that this is a critical aspect of investor behavior in illiquid markets. A reduction in trading frictions leads to an increase in the dispersion of asset holdings and trade volume. Transaction costs and intermediaries' incentives to make markets are nonmonotonic in trade frictions. With the entry of dealers, these nonmonotonicities give rise to an externality in liquidity provision that can lead to multiple equilibria. Tight spreads are correlated with large volume and short trading delays across equilibria. From a normative standpoint we show that the asset allocation across investors and the number of dealers are socially inefficient.
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| The Minimum Wage and the Labor Market
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May, 2007 |
Federal Reserve Bank of Cleveland, Economic Commentary |
Guillaume Rocheteau; Murat Tasci; |
Economic Commentary |
| Abstract: New models of employment show that there are some cases in which a minimum wage can have positive effects on employment and social welfare. The effects depend ultimately on the prevailing market wage and the frictions in the market. Evidence to date does not support the view that raising the minimum wage will lead to positive employment effects.
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| 2006 Summer Workshop on Money, Banking, and Payments?An Overview
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March, 2007 |
Federal Reserve Bank of Cleveland, Policy Discussion Paper, no. 18 |
Guillaume Rocheteau; Ed Nosal; Randall Wright; |
Policy Discussion Papers |
| Abstract: This Policy Discussion Paper summarizes the papers presented at the 2006 Summer Workshop on Money, Banking, and Payments. Every summer since 2002, some of the best researchers in the areas of theory, policy, and quantitative analysis relating to money, banking, and payments systems have met in Cleveland to discuss their latest work. The papers presented at the 2006 workshop cover a vast spectrum of issues and use a wide variety of methods. Still, there is an underlying theme, which is an effort to enhance our understanding of monetary economics, broadly defined, and to uncover new ways to think about important substantive issues. Hopefully, this helps not only theoretical monetary economists, but also economists such as central bankers with a more practical policy-oriented view.
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| Search in Asset Markets: Market Structure, Liquidity, and Welfare
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January, 2007 |
Federal Reserve Bank of Cleveland, Working Paper no. 0701 |
Guillaume Rocheteau; Ricardo Lagos; |
Working Papers |
| Abstract: This paper investigates how market structure affects efficiency and several dimensions of liquidity in an asset market. To this end, we generalize the search-theoretic model of financial intermediation of Darrell Duffie et al. (2005) to allow for entry of dealers and unrestricted asset holdings.
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| Understanding Unemployment
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October, 2006 |
Federal Reserve Bank of Cleveland, Economic Commentary |
Guillaume Rocheteau; |
Economic Commentary |
| Abstract: Modern economists have built models of the labor market, which isolate the market's key drivers and describe the way these interact to produce particular levels of unemployment. One of the most popular models used by macroeconomists today is the search-matching model of equilibrium unemployment. We explain this model, and show how it can be applied to understand the way various policies, such as unemployment benefits, taxes, or technological changes, can affect the unemployment rate.
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| Money and Capital as Competing Media of Exchange
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July, 2006 |
Federal Reserve Bank of Cleveland, Working Paper no. 0608 |
Guillaume Rocheteau; Ricardo Lagos; |
Working Papers |
| Abstract: We construct a model in which capital competes with fiat money as a medium of exchange, and establish conditions on fundamentals under which fiat money can be both valued and socially beneficial. When the socially efficient stock of capital is too low to provide the liquidity agents need, they overaccumulate productive assets to use as media of exchange. When this is the case, there exists a monetary equilibrium that dominates the nonmonetary one in terms of welfare. Under the Friedman rule, fiat money provides just enough liquidity so that agents choose to accumulate the same capital stock a social planner would.
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| Search in Asset Markets
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July, 2006 |
Federal Reserve Bank of Cleveland, Working Paper no. 0607 |
Guillaume Rocheteau; Ricardo Lagos; |
Working Papers |
| Abstract: We investigate how trading frictions in asset markets affect portfolio choices, asset prices and efficiency. We generalize the search-theoretic model of financial intermediation of Duffie, Gârleanu and Pedersen (2005) to allow for more general preferences and idiosyncratic shock structure, unrestricted portfolio choices, aggregate uncertainty and entry of dealers. With a fixed measure of dealers, we show that a steady-state equilibrium exists and is unique, and provide a condition on preferences under which a reduction in trading frictions leads to an increase in the price of the asset. We also analyze the effects of trading frictions on bid-ask spreads, trade volume and the volatility of asset prices, and find that the asset allocation is constrained-inefficient unless investors have all the bargaining power in bilateral negotiations with dealers. We show that the dealers' entry decision introduces a feedback that can give rise to multiple equilibria, and that free-entry equilibria are generically inefficient.
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| 2005 Summer Workshop on Money, Banking and Payments: An Overview
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April, 2006 |
Federal Reserve Bank of Cleveland, Policy Discussion Paper, no. 15 |
Guillaume Rocheteau; Ed Nosal; Randall Wright; |
Policy Discussion Papers |
| Abstract: This PDP summarizes the papers presented at the 2005 Summer Workshop on Money, Banking, and Payments at the Cleveland Fed. Papers covered a wide variety of topics in monetary theory and policy, banking, and payments systems research. Topics ranged from optimal monetary policy, optimal bank contracts, the private supply of money, the coexistence of credit, money, and capital, the design of payment systems, and international currencies. Effort was made to calibrate models and bring them closer to the data. These contributions illustrate the progress made in the field of monetary theory.
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| The Economics of Payments
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February, 2006 |
Federal Reserve Bank of Cleveland, Policy Discussion Paper, no. 14 |
Guillaume Rocheteau; Ed Nosal; |
Policy Discussion Papers |
| Abstract: In this paper we provide a survey of the payment literature in a unified framework. The environment is a variant of the Lagos and Wright (2005) model of monetary exchange, where some trades occur in bilateral meetings while others occur in more or less decentralized markets. We use this basic environment to introduce alternative sets of trading frictions that give rise to different payments instruments and/or payments institutions. We investigate credit economies, monetary economies, and economies in which money and credit coexist. We also study alternative assets, such as foreign exchange, capital (equity), and government liabilities, which can be used as payment instruments in conjunction with money. We introduce banks as deposit-taking institutions whose liabilities circulate in the economy. We also provide an extension in which the process of the settlement of debt for money is modeled and the potential social costs of settlement are characterized. Finally, we investigate government policy responses to the social costs introduced by various trading frictions.
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| Inflation and Welfare: A Search Approach
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January, 2006 |
Federal Reserve Bank of Cleveland, Policy Discussion Paper, no. 12 |
Guillaume Rocheteau; Ben R Craig; |
Policy Discussion Papers |
| Abstract: This paper extends recent findings in the search-theoretic literature on monetary exchange regarding the welfare costs of inflation. We present first estimates of the welfare cost of inflation using the "welfare triangle" methodology of Bailey (1958) and Lucas (2000). We then derive a money demand function from the search-theoretic model of Lagos and Wright (2005) and we estimate it from U.S. data over the period 1900-2000. We show that the welfare cost of inflation predicted by the model accords with the welfare-triangle measure when pricing mechanisms are such that buyers appropriate the social marginal benefit of their real balances. For other mechanisms, welfare triangles underestimate the true welfare cost of inflation because of a rent-sharing externality. We also point out other inefficiencies associated with noncompetitive pricing, which matter for estimating the cost of inflation. We then illustrate how endogenous participation decisions can mitigate or exacerbate the cost of inflaion, and we provide calibrated examples in which a deviation from the Friedman rule is optimal. Finally, we discuss distributional effects of inflation.
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| General Equilibrium with Nonconvexities, Sunspots, and Money
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December, 2005 |
Federal Reserve Bank of Cleveland, Working Paper no. 0513 |
Guillaume Rocheteau; Peter C Rupert; Karl Shell; Randall Wright; |
Working Papers |
| Abstract: We study general equilibrium with nonconvexities. In these economies there exist sunspot equilibria without the usual assumptions needed in convex economies, and they have good welfare properties. Moreover, in these equilibria, agents act as if they have quasi-linear utility. Hence wealth effects vanish. We use this to construct a new model of monetary exchange. As in Lagos-Wright, trade occurs in both centralized and decentralized markets, but while that model requires quasilinearity, we have general preferences. Given our specification looks much like the textbook Arrow-Debreu model, we think this constitutes progress on the classic problem of integrating money and general equilibrium theory. We also use the model to discuss another classic issue: the relation between inflation and unemployment.
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| On the Recognizability of Money
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December, 2005 |
Federal Reserve Bank of Cleveland, Working Paper no. 0512 |
Guillaume Rocheteau; Richard Dutu; Ed Nosal; |
Working Papers |
| Abstract: This paper develops a model of currency circulation under asymmetric information. Agents are heterogeneous and trade in bilateral matches. Coins are intrinsically valuable and are available in two weights, light and heavy. We characterize the equilibrium under complete information and under imperfect information about the quality of coins. We deter- mine a set of conditions under which the two currencies circulate and are traded according to di¤erent terms of trade. We study how output, welfare, and the velocity of currency are a¤ected by the recognizability of coins. We show that society.s welfare increases as coins become more easily recognizable.
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| The Tale of Gresham's Law
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October, 2005 |
Federal Reserve Bank of Cleveland, Economic Commentary |
Guillaume Rocheteau; Ed Nosal; |
Economic Commentary |
| Abstract: Gresham's law, which says that bad money tends to drive good money out of circulation, may account for many nations' episodes of money troubles, as far back as ancient Athens. This Commentary discusses the two main explanations for Gresham’s law and suggests some circumstances in which the law does not apply.
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| State-Dependent Pricing, Inflation, and Welfare in Search Econom
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May, 2005 |
Federal Reserve Bank of Cleveland, Working Paper no. 0504 |
Guillaume Rocheteau; Ben R Craig; |
Working Papers |
| Abstract: This paper investigates the welfare effects of inflation in economies with search frictions and menu costs. We first analyze an economy where there is no transaction demand for money balances: Money is a mere unit of account. We determine a condition under which price stability is optimal and a condition under which positive inflation is desirable. We relate these conditions to a standard efficiency condition for search economies. Second, we consider a related economy in which there is a transaction role for money. In the absence of menu costs, the Friedman rule is optimal. In the presence of menu costs, the optimal inflation rate is negative for all our numerical examples. A deviation from the Friedman rule can be optimal depending on the extent of the search externalities.
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| Bargaining and the Value of Money
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March, 2005 |
Federal Reserve Bank of Cleveland, Working Paper no. 0501 |
Guillaume Rocheteau; Christopher J Waller; |
Working Papers |
| Abstract: Search models of monetary exchange have typically relied on Nash (1950) bargaining or strategic games that yield an equivalent outcome to determine the terms of trade. By considering alternative axiomatic bargaining solutions in a simple search model with divisible money, we show how this choice matters for important results such as the ability of the optimal monetary policy to generate an efficient allocation. We show that the quantities traded in bilateral matches are always inefficiently low under the Nash (1950) and Kalai-Smorodinsky (1975) solutions, whereas under strongly monotonic solutions such as the egalitarian solution (Luce and Raiffa, 1957; Kalai, 1977), the Friedman Rule achieves the first best allocation. We evaluate quantitatively the welfare cost of inflation under the different bargaining solutions, and we extend the model to allow for endogenous market composition.
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| Rethinking the Welfare Cost of Inflation
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March, 2005 |
Federal Reserve Bank of Cleveland, Economic Commentary |
Guillaume Rocheteau; Ben R Craig; |
Economic Commentary |
| Abstract: New models of monetary economies, developed in the last 15 years, suggest that traditional measures of the welfare cost of inflation may underestimate the true loss that inflation inflicts on society. According to these models, the cost of 10 percent inflation ranges from 1 to 5 percent of real income.
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| Recent Developments in Monetary Economics: A Summary of the 2004 Workshop on Money, Banking, and Payments
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January, 2005 |
Federal Reserve Bank of Cleveland, Policy Discussion Paper, no. 8 |
Guillaume Rocheteau; Ed Nosal; Randall Wright; |
Policy Discussion Papers |
| Abstract: We provide a summary and an overview of the papers presented at the Federal Reserve Bank of Cleveland's 2004 Workshop on Money, Banking, and Payments, held during the weeks of August 3-7 and August 23-27, 2004. The papers presented at the workshop are available at www.clevelandfed.org/research/confpast.cfm
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| The Fate of One-Dollar Coins in the U.S.
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October, 2004 |
Federal Reserve Bank of Cleveland, Economic Commentary |
Guillaume Rocheteau; Sébastien Lotz; |
Economic Commentary |
| Abstract: The United States has introduced two one-dollar coins in the past 25 years, both of which have not circulated widely. Many other countries have replaced lower-denomination notes with coins and have achieved wide circulation and cost savings. Lessons from those countries suggest that achieving widespread use of a dollar coin is much harder if the note is allowed to remain in circulation.
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| Friedman Meets Hosios: Efficiency in Search Models of Money
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October, 2004 |
Federal Reserve Bank of Cleveland Working Paper no. 0408 |
Guillaume Rocheteau; Aleksander Berentsen; Shouyong Shi; |
Working Papers |
| Abstract: In this paper the authors study the inefficiencies of the monetary equilibrium and optimal monetary policies in a search economy. They show that the same frictions that give fiat money a positive value generate an inefficient quantity of goods in each trade and an inefficient number of trades (or search decisions). The Friedman rule eliminates the first inefficiency, and the Hosios rule the second. A monetary equilibrium attains the social optimum if and only if both rules are satisfied. When the two rules cannot be satisfied simultaneously, which occurs in a large set of economies, optimal monetary policy achieves only the second best. The authors analyze when the second-best monetary policy exceeds the Friedman rule and when it obeys the Friedman rule. Furthermore, they extend the analysis to an economy with barter and show how the Hosios rule must be modified in order to internalize all search externalities.
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| Inflation, Output, and Welfare
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August, 2004 |
Federal Reserve Bank of Cleveland, Working Paper no. 0407 |
Guillaume Rocheteau; Ricardo Lagos; |
Working Papers |
| Abstract: This paper studies the effects of anticipated inflation on aggregate output and welfare within a search-theoretic framework. We allow money-holders to choose the intensities with which they search for trading partners, so inflation affects the frequency of trade as well as the quantity of output produced in each trade. We consider the standard pricing mechanism for search models, i.e., ex-post bargaining, as well as a notion of competitive pricing. If prices are bargained over, the equilibrium is generically inefficient and an increase in inflation reduces buyers' search intensities, output, and welfare. If prices are posted and buyers can direct their search, search intensities are increasing with inflation for low inflation rates and decreasing for high inflation rates. The Friedman rule achieves the first best allocation and inflation always reduces welfare even though it can have a positive effect on output for low inflation rates.
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| Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium
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July, 2004 |
Federal Reserve Bank of Cleveland Working Paper no. 0405 |
Guillaume Rocheteau; Randall Wright; |
Working Papers |
| Abstract: We compare three market structures for monetary economies: bargaining (search equilibrium); price taking (competitive equilibrium); and price posting (competitive search equilibrium). We also extend work on the microfoundations of money by allowing a general matching technology and entry. We study how equilibrium and the effects of policy depend on market structure. Under bargaining, trade and entry are both inefficient, and inflation implies first-order welfare losses. Under price taking, the Friedman rule solves the first inefficiency but not the second, and inflation may actually improve welfare. Under posting, the Friedman rule yields the first best, and inflation implies second-order welfare losses.
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