Optimal Employment of Scale Economies in the Federal Reserve's Currency Infrastructure

This paper investigates whether the Federal Reserve might lower its currency processing costs by reallocating high-speed currency sorting volume among its processing sites. Although scale economy estimates from Bauer, Bohn, and Hancock (1998) suggests that consolidation might permit some processing cost savings, it can be very expensive to ship currency due to security and insurance requirements and these costs increase rapidly as currency is transported further and further from a given processing site. Given estimates of currency shipping costs and scale economies for high-speed sorting, our model determines the distribution of sorting volumes across possible processing sites that minimizes the Federal Reserve's overall costs. These cost savings are achieved while leaving service levels to depository institutions roughly constant. The sensitivity of our results is explored by employing a range of estimates for shipping costs and scale economies.