Tuesday, September 9, 2014

500 € ... sounds like a lot of money

Tom Brown asked if currency denominations had any impact on the price level in a comment here., and sent me to JP Koning's blog post about the macroeconomic impact of 500 € notes. What caught my eye was the shape of the 500 € note's contribution to M0. See, for awhile now (e.g. here), the shape of M0 has been a serious impediment to a good fit of the information transfer model to the EU price level. I always thought it had to do with the introduction of the Euro. The currencies of countries such as Italy's Lira continued to circulate for some time after the Euro notes were available -- I remember some prices were still in Lira when I was there in 2002 -- and I thought that the Euro M0 wasn't capturing that.

Here is the fit to the price level and inflation rate using M0 (including 500 € notes):

Not only is inflation too high at the introduction of the Euro, but it is way too low as you approach the present day. Here is a graph of M0 with and without the 500 € notes -- already you can see some of the variation disappear:


And sure enough, the fit is much improved if we leave them out:

There is still some impact at the introduction of the Euro, but overall, this is a much better fit -- in particular it gets present-day inflation about right.

Koning points out that the 500 € notes don't really circulate the way other denominations do (he cites that 9 of 10 notes are used for illegal purposes). Koning also points out that the existence of 500 € notes may impact effective short term interest rates (a negative IOR makes holding these zero-interest Euro notes a more attactive option) -- I plan on looking at the effect on interest rates in the future.

So how do we know whether or not to include a particular denomination? Well, only in the case of the 500 € note does it seem particularly obvious (empirically): it is particularly large with a particularly large volume. In other cases, it's probably not going to be very obvious. The question of what is considered "money" is of great interest -- maybe there are more examples out there.

If anyone would like to help me conduct an experiment -- please send me a few of these notes and I will keep them out of EU circulation and look at the impact on the price level. I will then travel to the EU (e.g. Paris) and personally put them back in circulation a few months later.

PS, the title reference ...

Update 9/9/2014: Fixed graph titles.


  1. When you talk about M0, I've always taken it to mean (and I think this post backs up that understanding) physical bills, right? Nothing electronic, but literally a sum of all the dead trees the treasury has pushed out the front door?

    My understanding is that the base you want to use is one that "enables" economic activity (i.e. MB doesn't help you put food on the table). But I get paid electronically, and I spend electronically - and all that should be counted in the model right? Unless you're arguing that M0 is proportional to a scaling factor of whatever aggregate base we really want to use... and hence we can get away with it...

    1. One of the functions of M0 in this model is to provide a definition of the unit of account (or unit of information). That defines inflation (the change in a unit of money in terms of market goods). The other measures like M1 or M2 don't define the unit of money in the same way (at least empirically ... Using those measures don't work to describe inflation).

      It appears as though MZM and M2 have an "exchange rate" relationship with M0 ... E.g. Here:


      I like to think of printed bills like the kilogram model in Paris ... A physical embodiment of a "unit".

    2. This is another link that discusses the unit of information ...


    3. Kilogram model in Paris... I didn't know that was the last one:



    4. ... and it might be headed for retirement too I guess.

    5. I didn't realize it was the last one either ... I guess they're not as necessary as the kilogram is defined in terms of Carbon atoms now ...

  2. I love your proposed experiment. Lol. Somehow I missed that on first read.

    1. No takers yet. I guess monetary economics is a theoretical discipline.


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Also, try to avoid the use of dollar signs as they interfere with my setup of mathjax. I left it set up that way because I think this is funny for an economics blog. You can use € or £ instead.