Capacity Choice, Monetary Trade, and the Cost of Inflation

Abstract Both buyers and sellers in decentralized markets make investments ex ante that constrain trading possibilities ex post: buyers decide in advance how much money to carry, while sellers decide how much inventory to stock. We show that the interaction between these choices naturally leads to indeterminacy of equilibrium. When neither inflation nor the scrap value of unsold goods is high, there is a continuum of equilibria in which buyers and sellers coordinate on their choices of money balances and capacity. Furthermore, at low inflation rates, traded quantities are pinned down by the seller’s capacity choice, and inflation therefore has no effect on output and welfare. We also contrast our results with other environments with strategic complementarities and discuss how they depend on the pricing mechanism.