A Unified Framework for Monetary Theory and Policy Analysis

TLDR

Search‑theoretic monetary models rely on frictions that make money essential, yet tractable versions often impose strong assumptions that limit their usefulness for policy analysis. The authors propose a unified framework with explicit micro foundations to study macro policy. The framework, grounded in explicit micro foundations, is calibrated to standard data to quantify inflation costs, making it analytically tractable. The model is analytically tractable and shows that reducing inflation from 10 % to 0 % yields a welfare gain of 3–5 % of consumption, higher than prior estimates.

Abstract

Search‐theoretic models of monetary exchange are based on explicit descriptions of the frictions that make money essential. However, tractable versions of these models typically make strong assumptions that render them ill suited for monetary policy analysis. We propose a new framework, based on explicit micro foundations, within which macro policy can be studied. The framework is analytically tractable and easily quantifiable. We calibrate the model to standard observations and use it to measure the cost of inflation. We find that going from 10 percent to 0 percent inflation is worth between 3 and 5 percent of consumption—much higher than previous estimates.