How Cost Efficient is the Eurosystem?

Abstract

The classical cost-saving argument for fiduciary media as suggested among others by Adam Smith and David Ricardo has been turned into an argument for an unbacked fiat money system by the early Milton Friedman. It holds that the production of commodity money, such as gold, is inefficient, as it ties up scarce resources in mining, minting, transportation and storage. These resources are diverted from more productive uses in other parts of the economy. Friedman estimated that the annual costs of a full-reserve gold standard would lie around 2.5% of GDP, which is arguably too high as he assumed full reserves on M2. Lawrence White later estimated the annual costs of a fractional-reserve gold standard to be 0.025% of GDP. Taking the latter estimate as a lower bound benchmark, it is shown in this case study that the annual operating expenses of the fiat standard of the euro area are in fact more than three times as high as White's estimate. But even when White's reserve ratio on M1 is substantially increased, the estimated costs of the gold standard and the actual operating expenses of the eurosystem remain in the same ballpark.

Keywords: Eurosystem; euro; ECB; fiat standard, gold standard

JEL Classification: E02, E50, E58, E59