INVENTORY ACCUMULATION IN A SEARCH-BASED MONETARY ECONOMY

This paper explores the implications of a search-based model of money for the linkage between steady state inventory accumulation, inflation, and welfare. Because individual traders in the search economy do not internalize the positive effects inventory accumulation and search effort have on the aggregate economy, they are too low relative to social efficiency. It is established that a tax on money balances can alleviate these externalities and improve aggregate welfare. It does so by (i) directly increasing the optimal search intensity choices of the individual trader and (ii) stimulating the accumulation of inventories through a 'Mundell-Tobin' type effect. An increase in the equilibrium level of inventory accumulation also positively affects search effort. The implications for optimal monetary policy are discussed.