The transaction role of money is one of the most palpable of economic phenomena and offers one of the first challenges for the theory of exchange. A useful analogy can be made between the role of money as a record-keeping device and the theory of signaling. The chapter discusses that the theory of exchange was developed as a response to the challenges of price determination and allocation of resources. The frictions required for monetary exchangesuch as differential costs of spot and forward transactions and the strategic issues of incomplete information and incentive compatibilityare recent developments. It explains the slow growth of the transaction role of money as a branch of the theory of exchange. The transaction role of money challenges the implicit logistical and informational assumptions of the theory of exchange. The sequential nature of trade makes informational demands that go beyond the knowledge of prices that suffices in the traditional theory of exchange. The chapter also examines the rationale behind the transaction role of money in a model exhibiting this dichotomy. Exploring the properties of models in which budget enforcement problems are always a binding constraint on behavior helps illuminate the understanding of macroeconomics.
