Self-confirming Price Dispersion in Monetary Economies

RePEc Short ID: pba1233
ORCID iD: 0000-0002-5532-2678

Baughman, Garth; Rabinovich, Stanislav

doi:10.17016/FEDS.2018.046

Working Paper

Self-confirming Price Dispersion in Monetary Economies

Abstract: In a monetary economy, we show that price dispersion arises as an equilibrium outcome without the need for costly simultaneous search or any heterogeneity in preferences, production costs, or search technologies. A distribution of money holdings among buyers makes sellers indifferent across a set of posted prices, leading to a non-degenerate price distribution. This price distribution, in turn, makes buyers indifferent across a range of money balances, rationalizing the non-degenerate distribution of money holdings. We completely characterize the distribution of posted prices and money holdings in any equilibrium. Equilibria with price dispersion admit higher maximum prices than observed in any single-price equilibrium. Also, price dispersion reduces welfare by creating mismatch between posted prices and money balances. Inflation exacerbates this welfare loss by shifting the distribution towards higher prices.

Keywords: Inflation; Money; Price dispersion; Search;

JEL Classification: D43; E31; E40;

https://doi.org/10.17016/FEDS.2018.046