Essays on monetary economics with a microfoundation

This dissertation consists of two essays concerning search-theoretic monetary economics. The issues studied here are about search and matching, which requires models with an explicit microfoundation. The meaningful economic intuitions and policy implications we get justify the necessity of this approach. The first essay studies the effect of inflation on welfare in a monetary economy with price dispersion and consumer search. When facing greater price dispersion, consumers search harder for lower prices. Increased search raises welfare by intensifying market competition. Producers post inefficiently high prices, which creates a welfare loss. Both mechanisms are affected by the consumer\u27s monetary balance. We develop a general equilibrium model with search frictions to incorporate the interrelationship of money, search and price dispersion, and study the welfare implication of inflation. Inflation affects welfare through three channels: the real balance channel, the search channel, and the price posting channel. We calibrate the model to U.S. data and find that the welfare cost of 10% annual inflation is worth 3.23% of consumption. If either the real balance or the price posting channel is closed, the welfare cost significantly decreases to less than 0.15% consumption. The price posting channel amplifies the welfare-diminishing effect of the real balance channel and the aggregated negative effect exceeds the positive effect due to the search channel. The search cost alone generates a negligible welfare loss. In the second essay, which is a joint work with Lucy Liu and Randall Wright, we study the relationship of inflation and velocity. Conventional wisdom is that inflation makes people spend money faster, trying to get rid of it like a hot potato, and this is a channel through which inflation affects velocity and welfare. Monetary theory with endogenous search intensity seems ideal for studying this. However, in standard models, inflation is a tax that lowers the surplus from monetary exchange and hence reduces search effort. We replace search intensity with a free entry decision for buyers, i.e. we focus on the extensive rather than intensive margin—and prove buyers always spend their money faster when inflation increases. We also discuss welfare at the end