UCLA

In this dissertation, I develop a monetary model where money is used in two roles: as the medium of exchange in spot transactions, and as the unit of account in credit contracts. I use this model to jointly study these two functions, comparing their properties and exploring their interactions.

In the first chapter, I present the model where money can be used as both medium of exchange and unit of account. These functions stem from limits to trade that can be partially overcome with the use of money. The unit of account role in contracts arises from the need to specify a payment, in terms of goods or money. Here, I establish the conditions for money to be chosen as the unit of account in terms of the stability of both relative prices and the general price level. I also illustrate the benefits of dollarization (writing contracts in a foreign currency) or indexation (allowing contracts to be specified in terms of an artificial unit of account).

I then analyze the stationary monetary equilibrium, where the value of money is determined from its demand as medium of exchange and a given monetary policy. As a result of this analysis, I provide several insights into these functions. For instance, the conditions that make money a good medium of exchange are different from the ones that make it a good unit of account. The unit of account role provides a rationale for a price stability goal of monetary policy, distinct from the goal of keeping a low inflation rate. Finally, the model illustrates how a currency can become a better unit of account as a result of being more widely used as a medium of exchange.

In the second chapter, I analyze two general approaches to monetary policy: inflation and price-level targeting. The former aims for a target level of inflation, while the latter attempts to keep the level of prices in an established path. In order to compare these two policies, I extend the benchmark model to incorporate long-term contracts. On one hand, price-level targeting enhances the long-term stability of the value of money, making it a better unit of account. On the other hand, inflation targeting is better for the medium of exchange role, since the inflation level is the relevant cost for the use of money in spot transactions. I argue that a combined approach resembles the recent Federal Reserve policy of "flexible average inflation targeting," and that indexation would allow monetary policy to sidestep this trade-off.