Bluematter.

Tyler Cowen (and the Economist Free Exchange) wonder why there's a shortage of small denomination coins in Italy. Here is Thomas Kaminski's letter to Tyler that sparked the debate:

There doesn’t seem to be enough currency in small denominations in circulation. Wherever I buy something, the merchant or cashier seems to ask for smaller bills or coins. Back home in Chicago, if I go into a Starbucks, I don’t give it a second thought if I give the cashier a twenty dollar bill for a $2.50 purchase. They always have plenty of change. Here, even in some supermarket chains, the cashiers constantly ask for exact change or at least for notes in smaller denominations. And when I go to a museum, they often seem to have no change at all... My wife, who is not as familiar with the currency as I am, says that she hates carrying any bill larger than a 10; she constantly gets dirty looks or has to endure sighs of frustration if she tries to buy a cup of tea and doesn’t have small change. And you should see the complications if you try to buy something from a street vendor and don’t have exact change.

Like many personal economic anecdotes, there's something amiss here. Look at what the possibilities are when we try to aggregate and see what happens to this economy at the macro level:

Possibility 1. There are hardly any small-denomination coins or notes in circulation in Italy. People never buy anything priced to two decimal places, and never buy 'small stuff' (or at least always buy them in bulk). There is no market for matches, chewing gum and bus tickets. Small shops stay open not because shop-keepers make a profit (they don't sell anything, as nobody has the appropriate change) but because they get a perverse satisfaction from telling people off when they try to pay for their purchases with 50-euro notes.

Possibility 2. There is actually enough - or at least some - amount of small-denomination currency in circulation, and local consumers (or certain sub-groups, such as kids and OAPs) somehow manage to hoard it all. They purchase all the chewing gum and matches they like with it. Note that, in the process, a lot of this small-denomination currency inevitably passes on to shop-owners. The latter, being avid coin collectors or looking for perverse satisfaction of the type described above, simply refuse to part with it when a hapless customer arriving later in the day attempts to pay for something with anything other than the exact amount.

Possibility 1 somehow doesn't seem likely - I assume that Italians consume their fair share of newspapers, espressos and mars bars. So, we have to settle for possibility number two - shopkeepers expect customers to hold change, and do not go out of their way to cater for those that don't.

Given that I was only kidding about Italian street vendors surviving on Schadenfreude, there must be some other reason why this practice persists. Here's my two cents' worth (if you haven't got the exact amount, read no further):

1. Keeping large amounts of cash in the till (large amounts of all sorts of notes and coins to be able to give exact change, as well as the large denomination notes customers use to pay with) is costly. To start with, cash in the till is not earning interest. There are shoe-leather costs as the shopkeeper has to go to the bank more frequently to exchange all the 50s and 100s for notes and coins he can use to give change. Tills with excess cash are also more attractive to all sorts of mean types, who instead of just being able to walk away with the day's revenue can now obtain some multiple thereof.

These costs are especially high when inflation is rampant and when plenty of bad guys (such as the Mafia) are around. To a large extent, Italy has got rid of the former and, arguably, the worst excesses of the latter - but the past does matter.

2. Being difficult about change is a great way to price-discriminate. People who are very price sensitive make sure they somehow obtain and carry around appropriate change with them at all times, people who are not that careful with their money have to live with paying 2 euros for a coffee priced at E1.78 or 10 euros for a souvenir worth E9.52. Alternatively, they end up buying an extra muffin or a few postcards of beautiful Italy. Both scenarios result to extra profit for the shopkeeper.

The change-less subsidise the consumption of the change-bearers, the quoted price is lower than it otherwise would be, and the shopkeeper sees an increase in sales and profits. And there are a few extra tricks to ensure customers that matter don't end up pissed off. While tourists and wanderers can do nothing about the 'rounding up' other than grin and bear it, price-sensitive frequent customers can claim the difference off future purchases (Luigi, keep tomorrow's espresso on tap!).

To sum it all up, it's unlikely there is a shortage of small denomination currency in Italy - that is, other than in shops' tills. Furthermore, don't expect this situation to change, no matter what coins are minted. Let's say a shopkeeper decides to start having, and handing out, correct change to everybody. He would end up with more cash in the till and less money in interest-bearing accounts (less profit), people not too fussed about change would receive change regardless (less profit), while quoted prices would have to be higher to make up the short-fall, driving away the locals who are aware there is a cheaper cafe a few meters down the street (you guessed it: less profit).

But wait a minute: if shopkeepers in Italy gain by following the 'no change' strategy, why are their US counterparts not adopting it? Plenty of reasons can be cited. For example, American shops have a greater tendency to be large, or part of a chain, than those in Italy - and would thus bear disproportionate reputational costs if they consistently dragged their feet when it came to change. The existence of the one dollar bill (the smaller euro note is the fiver), and potentially even greater circulation of small denomination currency might also be important factors.

I have a hunch, however, that the true answer lies in the past, and in the different economic experiences of Italy and the US. For some reason (lower historical inflation rates, greater labour mobility, etc), US customers have been receiving, and grown accustomed to receiving, exact change. Americans in Italy 'do like the locals' and shrug their shoulders when the paper vendor embezzles their twenty four cents worth of change - but try pulling that trick in a Starbucks in Chicago and the reaction will be very different.