Alex Bura Joseph Sheffu, ID: 19880513, Module code: EC534, Seminar leader: Jingwei Wu
Discuss advantages and disadvantages of governments issuing small denomination coins.
In the 20th century Small denomination coins and notes are known as fiat money. Fiat money is a
government issued currency that is not backed by a physical commodity. Money comes in three
different forms: commodity money, fiat money and fiduciary money. It functions as a medium of
exchange, a unit of account and a store of value for agents in the economy. Fiat money such as
notes, and coins is money that has no intrinsic value but is given value because those who use it
believe it has intrinsic value and they trust that the will government enforce its laws for it to be
accepted as means of payment for goods and services. This essay will discuss the benefits and
drawbacks of the government issuing small denomination coins such as the 1- and 2-euro cent coins
in the modern monetary systems and prior to the 20th century, where commodity money such silver
coins were used to facilitate exchange.
A benefit of the government issuing small denomination coins such as small silver coins, in the
medieval monetary systems that used commodity money, is that it increases welfare. This is mainly
because commodity money is a good with intrinsic value and is used as a medium of exchange.
However, in modern monetary systems the increase in welfare is lower as coins are now known as
fiat money and have no intrinsic value. It allows for trade to occur across generations, and this can
be shown in the OLG model of fiat money. Young individuals (Nt) have an endowment of goods (y) in
period t and will want to have an endowment of goods when they are old (Nt-1). Individuals want to
consume in both periods of their lives. However, goods are non-storable and old individuals do not
have any endowment of goods. There are two solutions to this economic problem, the first one is
known as a centralised solution, benevolent planner that aims to redistribute goods between all
individuals. The second solution is known a decentralised solution that involves trading with money
in a market economy. The issuing of coins allows for individuals to engage in small cash transactions
between the old and the young, this will increase the welfare of individuals. The young would sell
the endowment of goods they do not use to the old and store the money they receive to use it to
purchase goods when they are old.
Secondly, the benefit of the government producing small denomination coins such as 1- and 2-euro
cent coin is that it has a very low impact on inflation. These coins do not get re-circulated after
consumers use it for small transactions or cash transactions of which only make up a low proportion
of consumer spending. Most often consumers receive 1- or 2-euro cent as change from retailer
shops and it is handled as a non-value item which creates the problem of hoarding. Hoarding
prevents the recirculation of the 1- and 2-euro cent coins therefore the government must have an
ever-increasing supply of the coins because of the high loss rate of these denominations. Because
these coins only have a low contribution on economic growth. This benefits the government and the
economy as the increase in money supply of 1- and 2-euro cent coins has a low impact on the price
levels of goods and services.
On the other hand, a drawback of the government issuing small denomination coins is that they
have a high loss rate and are treated as non-value items. Consumers in the market rarely use the 1and 2-euro cent coins for purchases at retail shops and most often receive it as change for
purchases. This is because goods sold by retailers mainly use fractional pricing and goods are priced
as .99. These coins do not get recirculated because the face value of these coins is low and cannot
really be used to purchase any goods. An example of this is in the European market with the 1-euro
cent and 2-euro cent, the number of these ‘coins issued since the euro changeover in 2002 is in
excess of 46 bn coins.’ This is due to the ‘high loss rate of these denominations, which ranges from
25% up to almost 100%’.
Alex Bura Joseph Sheffu, ID: 19880513, Module code: EC534, Seminar leader: Jingwei Wu
Furthermore, a drawback of the government issuing small denomination coins is that it has high
production costs relative to face value. The use of coins comes with cost. The costs of coin
production include purchasing of raw materials such as metals for coin blanks, the production costs
of the coin blanks, the cost of the final production i.e., minting and many other costs related to
banks and retailers. These cost factors are indirectly charged to citizens and are less noticeable
because these costs are passed through sales tax, and other government revenue sources. In the
euro changeover in January 2002 the number of 1- and 2-euro cent coins produced was in excess.
‘Although the number of the 1- and 2-euro cent coins is very high, 46 bn, the total value of these
coins is only about 714 million, which only represents about 2.8% of the value of all euro coins in
circulation’. This indicates that the face value of small denomination coins issued by the government
is significantly less than the cost of producing these coins.
In addition to this, the production of small denomination coins by the government has a mixed
impact on state income, tax revenues and seigniorage. Seigniorage is the difference between the
face value of the coins and their production costs, which is the profit (state income) made by the
government for issuing these coins. ‘The cost of coin production and issuance are covered by state
income through tax contribution of citizens.’ The impact on seigniorage compared to the savings a
state can make by withdrawing the 1- and 2-euro cent coin is shown on the European commission
journal article in 2013 that discusses the potential withdrawal of these coins. The article states that
there would be a ‘mixed impact on the income of the member states in the euro area.’ Some
member states showed that there could be ‘substantial savings up to 4 times the face value’ of the
coins. For other euro area members ‘the seigniorage of those coins is still positive and this positive
income stream would be lost’.
In conclusion, the advantages and disadvantages of the government producing small denomination
coins over time have changed as monetary systems have also changed over time. The switch from
the commodity money to fiat money has minimized the impact on welfare as the purchasing power
of these coins has reduced over time. The development of technology over time has also reduced
the total amount of cash transactions occurring in economies therefore problems of hoarding small
denomination coins have increased. This is because technology advancement has increased the
amount of debit and credit card transactions. The disadvantages outweigh the advantages of small
denomination coins mainly because coin production is a loss-making activity and has high costs of
production. Abolishing the production of these coins could potentially benefit economies.
Alex Bura Joseph Sheffu, ID: 19880513, Module code: EC534, Seminar leader: Jingwei Wu
References
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Bde.es. 2013. Issues related to the continued issuance of the 1- and 2-euro cent
coins. [online] Available at:
<https://www.bde.es/f/webbde/EYC/billemone/ficheros/es/COM_2013_281_final_y_S
WD_2013_175_final_EN.pdf>.
KIM, Y. and LEE, M., 2012. Return on Commodity Money, Small Change Problems,
and Fiat Money. Journal of Money, Credit and Banking, 44(2-3), pp.533-549.
Sargent, T. and Velde, F., 2003. The Big Problem of Small Change. By
Thomas J. Sargent and François R. Velde. Princeton, N.J.: Princeton University
Press, 2002. Pp. 432. Journal of Political Economy, 111(2), pp.459-463.