The mechanism design approach to monetary theory

The mechanism design approach to monetary theory is the search for fruitful settings or environments in which something that resembles monetary trade actually accomplishes something— or, in Hahn’s [7] terminology, in which money is essential. Fruitfulness means that the settings provide new insights about puzzling observations and policy questions. The search for settings in which money is essential is hardly new. Suggestions about absence-of-double-coincidence di¤culties go back at least to Roman times (see Monroe [14]). However, despite being repeated over and over again ever since, those statements are incomplete. After all, if they were regarded as satisfactory, then the search would long ago have been regarded as over. If it were over, then the problem of integrating price theory and monetary theory would not have been one of the big unsolved problems in economics throughout the 20th century— as evidenced, for example, by the opening remark in a 1996 paper by Banerjee and Maskin [2]: “Money is something of an embarrassment to economic theory.” Monetary trade accomplishes something if monetary trade is necessary for the achievement of some desirable allocations. To establish such necessity, it must be shown that there is no other way to achieve those allocations. That, in turn, requires that all other ways be considered. Mechanism design is the tool that can be used to consider all other ways. Needless to say, models with cash-inadvance constraints— or, more generally, models with asset-speci…c transaction costs— and models with real balances as arguments of utility or production functions are not among the candidates for settings in which monetary trade is