“On the Emergence of Monetary Exchange” by Brett NORWOOD
University of Hong Kong
While in recent years economists have developed economic models showing how the use of money as a medium of exchange can be an equilibrium outcome, there has been almost no analysis of the dynamic process by which monetary exchange arises. In this paper, I characterize circumstances under which agents endogenously choose to circulate a durable good as money due to the presence of technological progress. I show that if the durable good yields even an arbitrarily small flow utility, then there exists a unique equilibrium with the following properties: agents initially do not engage in trade, then begin to barter, and finally circulate the durable good as money in exchange for the consumption good. I explore the timing of the advent of monetary exchange, studying how agents' anticipation that monetary exchange will eventually occur effects its emergence at an earlier date through a process of backwards induction. Finally, I consider the case when money becomes fiat in the limit, and characterize conditions for which there still exists a unique equilibrium in which monetary exchange emerges.