Will the Fed Refill America’s Piggy Banks?

I recently pointed out that there is a sense in which the low production of nickels during the early 1930s “caused” the Great Depression.  I suppose I was sort of half-kidding, and in a moment I will explain which half was serious.  A commenter named Steve recently sent me evidence that it was happening all over again:

I found your statistics on US nickel production chilling due to the parallels today in quarter production.  I view the quarter today as similar in utility to the nickel in the 1930s.  I know, the quarter has half as much purchasing power today as the nickel did then, but since we don’t generally circulate larger coins, the quarter today serves as the primary medium of exchange (and change) in small transactions.  Anyway, here are quarter mintages in recent years:

2006  2,928,800,000
2007  2,712,440,000
2008  2,438,200,000
2009    636,200,000
2010    177,200,000 (January through June)

I was worried that this might be related to the phase-out of the state quarter program (which are hoarded by collectors) so I decided to check some other denominations:

The United States Mint has halted production of circulating 2009 Jefferson nickels and 2009 Roosevelt dimes for the rest of this year, according to the latest issue of Coin World. As the dime and nickel production graphs show, the stoppage creates historic, staggering low mintages for the two coins — levels not seen since the 50s.

Coin Word’s Paul Gilkes reports the US Mint made the announcement on April 23, and included details of a scale back in producing for other circulating coins, like the three remaining 2009 Lincoln Pennies.

It’s not that the public or collectors dislike the new coins. Quite the opposite, in fact. Collector demand for 2009 circulating coinage is exceptionally high. It’s all about the recession. It has, by itself, significantly eroded demand for new coins in every day transactions.

Why? In addition to buying less, consumers as a whole no longer hoard loose change at home. They spend or cash it in, replenishing circulating supplies to such an extent that coin inventories at banks have climbed. Banks, in turn, cut Federal Reserve orders for new coin shipments. Federal Reserve banks do the same to the Mint, which is then forced to slash production.

Electronic transactions has already cut into demand for circulating coins over the last several years. The latest news from the Mint, however, overshadows how drastic demand for coins has been affected due solely to the recession.

Using the latest Mint circulating coin production figures for 2009 Jefferson nickels, 39.36 million from Denver and 39.84 million from Philadelphia were struck, for a total of 79.20 million coins. In contrast, 640.6 million nickels were minted last year. That is an astonishing 87.6 percent reduction. The last time a U.S. nickel had such a low combined mintage was in 1951.

I feel sorry for this country.  The Fed’s tight money policy is making Americans so desperate that they are emptying piggy banks and searching under couch cushions for spare change.  Isn’t there a better way to increase the money supply!

One test of whether the drop in production is primarily due to less transaction, or less coin hoarding, is to look at currency in circulation by denominations.  If there is no drop in one dollar bills, then the main problem is emptying piggy banks.  If one dollar bill production is dropping, then transactions are also falling.  Sure enough, in 2009 one dollar bill production was at the lowest level since 1983 (the last time we had 10% unemployment.)

Production of $100 bills reached a record in 2009, as demand for cash hoards obviously rises when the opportunity cost of holding cash falls close to zero.  Interestingly, the total amount of cash in circulation has not gone up very much in recent years, suggesting that cash and T-bills are not close substitutes.  There are two reasons why our academic eggheads are wrong in assuming cash and T-bills become close substitutes at zero rates.  Law-abiding people don’t like to hold lots of cash, because they fear losing it to thieves.  Those who do hoard lots of cash are trying to avoid taxes, or engaging in transactions that they don’t want the government to know about.  T-bills lack the anonymity of cash.

The Fed controls the monetary base (coins, currency and bank reserves at the Fed.)   All other nominal variables are endogenous.  This includes NGDP, the price level, the broader monetary aggregates, and the various denominations of currency and coins.  And it also includes bank reserves.  The Fed can also influence the demand for bank reserves by changing reserve requirements or the interest paid on reserves.

What does all this mean?  Take Friedman and Schwartz’s theory that the Fed caused the Great Depression by allowing M2 to fall sharply.  Given that the Fed doesn’t directly control M2, does it make sense to use the term “cause?”  It does under three conditions:

1. The Fed can control M2 indirectly.
2. M2 stabilization would have prevented the Great Depression.
3. M2 stabilization is a desirable monetary policy.

The first is true under fiat money, but may not be true under the gold standard.  The second is probably true, and the third is highly debatable.  Nevertheless, although I don’t happen to favor targeting M2, I think their proposed policy is defensible enough that they are justified in calling the Fed’s decision to allow a big drop in M2 a “cause” of the Depression.  The may be right or they may be wrong, but they aren’t misusing the term ’cause.’  As an analogy, the Fed doesn’t directly control the fed funds rate; rather they influence it through open market operations.  Sometimes the market rate differs from the Fed’s target.  But people frequently suggest that Fed changes in the short term interest rate “caused” some other change in the economy (such as the housing bubble.)

Coins are kind of like M2.  The nominal demand for coins is strongly correlated with nominal purchases of goods and services (but not assets.)  This is convenient because the nominal expenditure on goods and services (but not assets) just so happens to be NGDP.  So if the Fed had moved the monetary base in just such a way that coin production remained stable, then NGDP also would have presumably been fairly stable, and the Great Recession probably would not have happened.

On the other hand it is probably not a good idea to target coin output.  Coin velocity is not completely constant, and hence directly targeting NGDP futures is a superior policy.  And there may be multiple equilibria.  For instance low nickel production could be associated with either deflation, or a hyperinflation that is severe enough so that nickels are no longer used for even the most basic purchases.

PS:  I hope that this post will melt the hard hearts of our inflation hawks at the Fed.  Is there anything more pathetic than little girls having to empty their piggy banks to help buy food for the family?  Won’t the Fed provide just a bit more money?  And please, more nickels, not more excess reserves that banks earn interest on, but only so long as they don’t share the money with the rest of us.

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