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January/February 2000, 
Vol. 82, No. 1
Posted 2000-01-01

Money in a Theory of Exchange

Major problems in monetary economics are to introduce money into the economy in a way that explains how money arises endogenously; explain why money is preferred to other methods of exchange; and identify the welfare gains from using money. In this paper, the author develops a framework for assessing money’s role in the economy and identifies the welfare gains associated with its use. In his framework, money is welfare enhancing not only because it reduces the resources necessary for exchange—thereby increasing both consumption and leisure—but money further increases welfare by promoting further trade and greater specialization. The author then discusses the implications of his analysis for several important issues in monetary theory: the existence of fiat money; the role of money and credit in exchange; the asset demand for money; the buffer-stock notion of money demand; the welfare benefits of money; and the welfare costs of inflation.