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 need strong assumptions that make them ill-suited for studying monetary policy. We propose a framework based on explicit micro foundations within which macro policy can be analyzed. The model is both analytically tractable and amenable to quantitative analysis. We demonstrate this by using it to estimate the welfare cost of in ‡ation. We …nd much higher costs than the previous literature: our model predicts that going from 10% to 0% in ‡ation can be worth between 3% and 5% of consumption.

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Suppose that n buyers each want one unit and m sellers each have one or more units of a good. Sellers post prices, and then buyers choose sellers. In symmetric equilibrium, similar sellers all post one price, and buyers randomize. Hence, more or fewer buyers may arrive than a seller can accommodate. We call this frictions. We solve for prices and the endogenous matching function for finite n and m and consider the limit as n and m grow. The matching function displays decreasing returns but converges to constant returns. We argue that the standard matching function in the literature is misspecified and discuss implications for the Beveridge curve.We have benefited from the input of many people at many conferences and workshops, including

The goal of this paper is to extend existing search-theoretic models of fiat money, which until now have assumed that the price level is exogenous, by explicitly incorporating bilateral bargaining. This allows us to determine the price level endogenously and leads to additional insights concerning the role of money. For example, we find that monetary equilibria are generally inefficient in the sense that output and prices differ from the solution to a social planner's problem, although the difference can become small as the discount rate or search friction vanishes. We also find that there exist nonstationary inflationary equilibria.

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