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transactions (increasing demand of the general

Fed also reduced the highest marginal reserve

public) and decrease the average amount people

requirement on net transaction deposits (check-

hold (decreasing demand of the general public).

ing accounts) from 12 percent to 10 percent in

Our impression that the latter effect dominates is

April 1992.

supported by Kenneth N. Daniels and Neil B.

12. Milton Friedman, "The Fed's Thermostat," Wall

Murphy, "The Impact of Technological Change on

Street Journal, August 19, 2003, p. A8; George A.

the Currency Behavior of Households: An Empiri-

Selgin, The Theory of Free Banking: Money Supply under

cal Cross-section Study," Journal of Money, Credit

Competitive Note Issue (Totowa, NJ: Rowman and

and Banking 26 (November 1994): 867­74. ATMs

Littlefield, 1988) ; Lawrence H. White, The Theory of

also tend to shift the composition of bank reserves

Monetary Institutions (Malden, MA: Blackwell, 1999).

toward vault cash and away from deposits at the

See also Stephen Horwitz, Monetary Evolution, Free

Fed.

Banking and Economic Order (Boulder, CO: Westview

9. Richard G. Anderson and Marcela M. Williams,

Press, 1992). Robert L. Greenfield and Leland

"U.S. Currency at Home and Abroad," Federal Reserve

Yeager reach the same conclusion using a different

Bank of St. Louis Monetary Trends, March 2007;

argument under a slightly different set of con-

Anderson "Some Tables of Historical U.S. Currency

straints in "Can Monetary Disequilibrium Be

and Monetary Aggregates Data," Federal Reserve

Eliminated?" Cato Journal 9 (Fall 1989): 405­19.

Bank of St. Louis Working Paper 2003-006A (April

13. Again, all estimates of the monetary aggre-

2003); and Anderson and Robert H. Rasche, "The

gates came from the St. Louis Fed website:

Domestic Adjusted Monetary Base," Federal Reserve

http://research.stlouisfed.org/fred2/. We calculat-

Bank of St. Louis Working Paper 2000-002A (De-

ed income velocity using nominal GDP.

cember 1999). One reason we suspect that these esti-

mates of the increase in currency held abroad are too

14. Reserve ratios are calculated using our esti-

low is that they leave currency in domestic circula-

mates of total reserves as described in n. 7.

tion still growing at the annual rate of 5.3 percent,

higher than the growth rate of M2 deposits (4.6 per-

15. For the text of the Financial Services Regulatory

cent). A good lower-bound estimate for the growth

Relief Act of 2006 (signed by President Bush on

of domestic currency is the growth of that compo-

October 13), go to frwebgate.access.gpo.gov/cgi-bin

nent of currency not issued by the Fed--Treasury

/getdoc.cgi?dbname=109_cong_bills&docid=f:s28

coins--which is unlikely to be exported in significant

56enr.txt.pdf. Bank reserves that pay interest cease,

amounts. The annual growth rate is about 4 percent

in economic jargon, to be outside money (i.e., assets

over a comparable period. Federal Reserve Bulletin

only), and unless the dollar is redeemable for some

no. 73, March 1987, pp. A4, A10, and Federal

nonmonetary good(s), only the demand for pure

Reserve Statistical Release H.4.1, "Factors Affecting

outside fiat money itself fixes the dollar's purchas-

Reserve Balances," December 29, 2005.

ing power. As Don Patinkin in Money, Interest, and

Prices: An Integration of Monetary and Value Theory,

10. Milton Friedman, "Monetary Policy for the

2nd ed. (New York: Harper and Row, 1965), pp.

1980s," in To Promote Prosperity: U.S. Domestic Policy in

15­33, taught economists years ago, the medium of

the Mid-1980s, ed. John H. Moore (Stanford: Hoover

account must actually be traded on some market

Institution Press, 1984), and "Monetary Policy:

(or combination of markets) for the price level to be

Tactics versus Strategy," in The Search for Stable Money,

determinate. By converting part of the monetary

ed. James A. Dorn and Anna Jacobson Schwartz

base into government debt earning no seigniorage,

(Chicago: University of Chicago Press, 1987).

interest on reserves also will exacerbate some of the

Another advocate of freezing the base is monetary

potential interactions between fiscal and monetary

historian Richard H. Timberlake; see his "Insti-

policy discussed at length in the extensive literature

tutional Evolution of Federal Reserve Hegemony,"

surrounding Thomas J. Sargent and Neil Wallace's

Cato Journal 5 (Winter 1986): 760­61.

classic article, "Some Unpleasant Monetarist Arith-

metic," Federal Reserve Bank of Minneapolis Quarterly

11. Richard G. Anderson and Robert H. Rasche,

Review 5 (Fall 1981): 1­17.

"Retail Sweep Programs and Bank Reserves,

1994­1999," Federal Reserve Bank of St. Louis Review

16. Economists will no doubt notice the similarity

83 (January/February 2001): 51­72. After passage

between this evolution and the Walrasian model of

of the Depository Institutions Deregulation and

general equilibrium, where one good is arbitrarily

Monetary Control Act of 1980, nonpersonal time

designated numeraire without ever serving as a

deposits were the only component of M2 (not

medium of exchange. This evolution is also what is

included in M1) against which the board of gov-

essentially predicted by the legal-restrictions theory

ernors could impose reserve requirements. In

of monetary demand: see Neil Wallace, "A Legal

December of 1990 the Fed reduced that require-

Restrictions Theory of the Demand for `Money'

ment from 3 to 0 percent, as well as the reserve

and the Role of Monetary Policy," Federal Reserve

requirement against Eurocurrency liabilities. The

8