The Hahn Problem

This our weekly discussion of the price level as it relates to Perry Mehrling's money view. The price level is the average price of goods in terms of money or, equivalently, the price of money in terms of goods. But what determines the price level? Why is the price level important? And how does it fit into the money view?

The price level — the average price of goods in terms of money — is the reciprocal of the price of money in terms of goods. This week, we're exploring the Hahn problem, which poses the question of how money can have positive value in a general equilibrium model.

We are reading Frank Hahn's 1965 Essay "On Some Problems Of Proving the Existence of an Equilibrium in a Monetary Economy" in which he poses the problem.

From Perry Mehrling's lecture notes:

Most economists, following Frank Hahn (e.g. Money and Inflation 1982), see the absence of money as a weakness of the general equilibrium theory. The theory doesn’t have anything to say about the monetary phenomena and institutions that are apparently so important in the real world. The response of economists has been to try to develop models in which markets are less perfect, so there is a place for money. Three approaches can be distinguished:

1) Overlapping generations, money as a store of value (Wallace “The Overlapping Generations Model of Fiat Money”1980)

2) Search and matching models (Kiyotaki and Wright “On Money as a Medium of Exchange” 1989)

3) Walrasian GE with transactions costs (Starr “Monetary General Equilibrium with Transactions Costs” 2005)

All of these take as their problem the exchange of commodities in a world without any financial assets except money (i.e. an extension of our first model), and they show that money plays a role. The problem is that, quite generally, these results do not generalize to a world with financial assets because money, paying no interest, is a dominated asset.

Our weekly standing Zoom meeting time is 12 pm Eastern Time (America/New York) every Thursday.

See our Discord server for ongoing discussion: https://discord.gg/NJMyew58