Endogenous Liquidity and Currency Unions

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.