Estimating Optimal Denominations

Abstract

Two distinct approaches have been taken in the literature to consider the optimal denominations of coins and banknotes. One approach reduces the problem to determining the smallest set of denominations capable of handling a given range of transactions. Another approach argues the optimal denomination structure would minimize the number of coins and banknotes used in the average transaction. Both are ultimately concerned with the optimal spacing of denominations. In contrast, I estimate the average range of denominations for coins and banknotes conditional on real income and the monetary unit employed. To illustrate the practical application of this approach, I use the estimates as a benchmark for evaluating the payment system of Somalia emerging after the state collapsed in 1991. I show that the surviving 1000 Somali shillings note is too small for conveniently making large transactions, but too large to make precise change in small transactions.