General Equilibrium Foundations of Finance: Structure of Incomplete Markets Models

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Octavio A. Christian Ghiglino University of Essex Verified email at essex. Verified email at balasko. Articles Cited by Co-authors. Econometrica: Journal of the Econometric Society, , Journal of mathematical economics 19, , Journal of Mathematical Economics 2 2 , , The Review of Economic Studies 62 3 , , Essays in Honor of Kenneth J. Edited by W. Heller, R. Journal of Mathematical Economics 6 3 , , Articles 1—20 Show more. Help Privacy Terms. The structure of financial equilibrium with exogenous yields: the case of incomplete markets Y Balasko, D Cass Econometrica: Journal of the Econometric Society, , The overlapping-generations model.

Some results on uniqueness and on stability of equilibrium in general equilibrium theory Y Balasko Journal of Mathematical Economics 2 2 , , Economic equilibrium and catastrophe theory: An introduction Y Balasko Econometrica: Journal of the Econometric Society, , The graph of the Walras correspondence Y Balasko Econometrica pre 43 , , The transfer problem and the theory of regular economies Y Balasko International Economic Review, , In both cases the integration of monetary and value theory amount to collapsing all individuals into a single one.

This negates the very economic problem i. En otras palabras, la prueba de existencia del equilibrio general presupone la existencia de 'dinero interno'. Esto explica la importancia y necesidad de introducir 'el dinero externo' en el marco del equilibrio general. The proof of the market clearing equilibrium is the cornerstone of mainstream Neo-Classical Neo-Walrasian economic theory. The proof of existence and the assumptions on which it is based have not been exempt from criticism.

One of the most important is that the proof of existence does not need the existence of money. In a Neo-Walrasian world even of the temporary equilibrium variety transactions are planned for by the deus-ex-machina. Price information is costless and complete and quantities are only of relevance for the auctioneer. The addition of money to the model is viewed as unnecessary. It does not serve any particular purpose.

It is simply an inessential addition to the Neo- Walrasian construct: "there is nothing we can say about the equilibrium with money that we cannot say about the equilibrium of non-monetary economy" Hahn, , p. This interpretation is from my point of view incorrect. As made clear by some of the main general equilibrium theorists, in particular Gerald Debreu , the proof of existence of general equilibrium requires an accepted system of credits and debits.

It requires a system of privately issued IOU's, 3 that is commitments by private agents to deliver a certain quantity of a given commodity at a given equilibrium price. In other words, the proof of the existence of general equilibrium presupposes the existence of 'inside money,' credit balances of the private sector based on its own debt.

But an exchange based economic system with pure inside money is not compatible with the main principles of Neo-Classical monetary theory. In fact, inside money deprives Neo- Classical economics from having a monetary theory. Moreover, the fact that in a general equilibrium framework, inside money precedes the existence of outside money sharply contradicts most Neo-Classical accounts both 'historical' and logical accounts of the existence of money and its evolution. According to these outside money always comes into existence prior to inside money.

Moreover inside money appears as a consequence and logical result of outside money. The required incorporation of outside money is generally, and perhaps mistakenly so, presented as the integration of money and value theory the determination of equilibrium relative prices and quantities in the absence of money, i.

In reality, it is the integration of outside money to a system purely driven by inside money in order to rationalize the basic points of Neo-Classical monetary theory and make it consistent with the premises of general equilibrium.

Pdf General Equilibrium Foundations Of Finance Structure Of Incomplete Markets Models

A representative attempt at integrating 'money and value,' that of Patinkin a [] involved appending a quantity theory equation into a real determined general equilibrium system. Patinkin claimed that the integration of money and value theory led to an internal contradiction termed the 'invalid dichotomy. In order to solve this problem Patinkin introduced the real balance effect the Pigou effect.

The real balance effect restored the required consistency between the real and monetary sectors only by assuming that all economic agents in the economy are one and the same. A more recent attempt spurred by the overlapping generations approach to modeling trying to introduce explicitly the notion of outside money as a medium of exchange arrives exactly at the same solution.

A one agent economy makes the whole exercise, even proof of general equilibrium, pointless. In this sense, introducing outside money to preserve the main principles of Neo-Classical monetary theory within a Neo-Walrasian framework involves negating the very act of multiple exchanges that gave rise to general equilibrium theory and the requirement of the market clearing proof.

The solutions provided not only have proved to be futile but, more importantly, highlight the impossibility of introducing outside money into a generalized system of exchange driven by inside money. The paper is divided into six sections. The second focuses on the distinction between inside an outside money. The third and fourth section center on Patinkin's integration of monetary and value theory. The last section concludes.

It was originally developed by Arrow and Debreu and McKenzie At this market clearing or equilibrium price vector no agent wishes to make additional trades. This can be stated formally using a net notional aggregate demand approach. The proof of existence does not require the introduction of a generalized and accepted means of exchange. Nor does it require a theory of a generalized and accepted means of exchange.

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However, since general equilibrium analysis is undertaken in notional, ex-ante terms, the compatibility of all plans of all agents over a range of commodities requires necessarily the existence of an accepted system of credits and debits. This is made explicit by Debreu Since the Arrow-Debreu and other 'classic proofs' follow the same logic as that of Debreu ibid. Debreu ibid. Thus the role of prices is as follows. With each commodity is associated a real number, its price.

When an economic agent commits himself to accept delivery of a certain quantity of a commodity, the product of that quantity and the price of the commodity is a real number written on the debit side of his account. This number will be called the amount paid by the agent. Similarly a commitment to make delivery results in a real number written on the credit side of his account, and called the amount paid to his agent.

From the description provided by Debreu, all economic agents record their exante transactions in balance sheets with their respective debits and credits. The sum of these credit and debits should equal to zero for the whole if all actions by all agents are indeed compatible. Even though in this model there is no single good serving as means of exchange, exchanges are undertaken on the basis of private issued IOUs, that is commitments by private agents to deliver a certain quantity of a given commodity at a given equilibrium price.

In other words, transactions in this Debreu type economy and by extension in other proof of existence exercises including Arrow-Debreu, ; McKenzie, ; and Arrow and Hahn, [] , are undertaken on the basis of private debt or which is the same thing on the basis of credit. In these types of models all agents redeem their promises pay their debts. That is, agents trust one another and default is not contemplated. It can be argued as Gale does , pp.

Since in an equilibrium with trust there is 'no distinction between contracts and their execution' as put by Gale, , footnote 4 above there is nothing in the model that prevents the privately issued IOUs from circulating as 'transferable, negotiable instruments. In Neo-Classical monetary theory the term inside money refers to credit balances of the private sector which are based on the debt of the private sector.

Any change in the asset side of the private sector's consolidated balance sheet is matched exactly by a corresponding liability change Fry, Since inside money is at the same time is both an asset and a liability to the private sector, inside money is said to be in zero net supply within the private sector.

Inside money is contra posed to outside money, which refers to money created outside the private sector, money balances that 'are matched by net claims on the public sector or foreign assets' Goodhart, , p. At a general level, this includes "whatever government liabilities are used to buy and sell goods by the public to purchase and sell goods and services plus those assets used by banks to settle inter-bank transactions" Anderson, This tends to correspond roughly to high powered money monetary base or central bank credit. Outside money is the core and central concept of 'money' in Neo-Classical monetary theory.

This in turn leads by chain reasoning to the type of problems and issues that are central to the current Neo-Classical monetary debate, such as credibility and reputation.

Inside money is a different animal. Assume, as non-mainstream economists do i. If the borrower uses the bank deposit to pay for goods and services or cancel a debt, the borrower simply transfers the spending power to another agent. Here, the IOU creates the loan and the loan creates the deposit or the asset entry.

The repayment of the loan extinguishes the demand deposit and the IOU. In the same way as in a pure inside money story, liabilities and assets cancel out and there can never be 'an excess supply of money'. Money is in 'zero net supply within the private sector. As Lavoie , p.

Within the logic of the story, outside money not only precedes the existence of inside money but also outside creates inside money. That is, inside money would not exist without the prior existence of outside money. An illustrative example is provided by Gurley and Shaw In a second stage, inside money is introduced pp.

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Bonds are purchased by the government with newly created money or by consumers. Consumers can acquire bonds, money issued by the government or both. Finally in a third stage, the security differentiation model pp. In the later inside money precedes outside money and in fact it shows that outside money is an unnecessary artefact. However, at the same, as explained above, outside money is required in the model. Many, if not most, policy recommendations fall to the ground as these are anchored precisely around the theory of money.

Hence, the importance and necessity of introducing outside money and make it compatible with the Neo-Walrasian general equilibrium framework. This has come to be known in the literature as the integration of money and value theory, where by value theory it is meant the determination of relative prices by the real forces preferences, technology and endowments under the assumption of barter.

But by the logic of our argument, this is incorrect. Thus the so called integration of money and value is actually the introduction of outside money in a framework where inside money already exists and where exchanges are based on credit. One of the most representative attempts at integrating 'money and value theory' is that of Patinkin's Money, Interest and Price. An Integration of Monetary and Value Theory a [].

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