Academic journal article Journal of Money, Credit & Banking

Whither Loose Change? the Diminishing Demand for Small-Denomination Currency

Academic journal article Journal of Money, Credit & Banking

Whither Loose Change? the Diminishing Demand for Small-Denomination Currency

Article excerpt

"Except for the smallest of transactions, money will no longer be a physical thing." (Forbes 1967 as cited in Flannery 1996)

"The use of cash and currency will drop drastically ..." (Flannery and Jaffee 1973)

"Cash is dirty, inefficient--and obsolete." (Gleick 1996)

"The end of the cash era." (The Economist 2007, cover page)

WHILE MANY OBSERVERS have predicted the replacement of cash for decades, cash holdings remain significant and show few signs of decline in the aggregate. During the last 15 years, retail electronic payments have grown rapidly in most advanced countries. More recently, many traditionally cash-only establishments such as fast food restaurants, vending machine operators, and taxis have started to accept cash alternatives resulting in greater downward pressure for transactional cash demand. If there are more merchants accepting cash alternatives and more consumers using them, why is the stock of cash still so high? A significant part of the answer is that cash is not solely used as a means of payment.

In this article, we are primarily interested in answering the following question. Given greater usage of cash alternatives, are households and businesses holding less cash to make and accept payments! We disentangle cash's transactional role from its store of wealth role by categorizing currency into different denomination classes--small, medium, and large. We find evidence that greater usage of debit cards indeed reduces the transactional demand for cash--most notably, the demand for smaller denomination currency notes and coins. In addition, we find that greater consolidation in the retail industry also contributes to lower transactional demand for cash, suggesting that larger merchants may be better able to absorb the fixed costs of accepting electronic payments.

This question is of interest to economists and policymakers for several reasons. Most directly, greater usage of cash substitutes affects how much cash the central bank should supply and also influences the income and interest rate elasticities of money demand. The implications of a possible reduction in currency demand for monetary policy has been an active area of economic research (Friedman 1999, Freedman 2000, Goodhart 2000, Woodford 2000, Kroszner 2003, Chakravorti 2006, Alvarez and Lippi 2007). Moreover, some economists have suggested that social welfare would improve if fewer cash transactions took place (De Grauwe, Buyst, and Rinaldi 2000, Van Hove 2004). Finally, there has been considerable debate among economists regarding the role of financial incentives on the adoption of electronic payments and its impact on the demand for paper-based payment instruments (Humphrey, Pulley, and Vesala 1996, Chakravorti and McHugh 2002, Markose and Loke 2002).

We discuss payment trends in 13 Organisation for Economic Co-operation and Development (OECD) countries--Austria, Belgium, Canada, Finland, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States--from 1988 to 2003. We find that in most countries, debit card usage has increased significantly. However, the aggregate demand for cash has not fallen drastically with widespread adoption of noncash payment instruments. Unlike other payment instruments, cash serves as a universally accessible store of wealth in addition to being a payment medium. Thus, any analysis of the impact of cash alternatives must first disentangle the two competing functions of cash. Furthermore, in contrast to payment cards, cash transactions are more difficult to trace to the transactors because it can be used multiple times without third-party intervention. Consequently, cash will continue to be attractive for facilitating illicit transactions, as well as for storing ill-gotten (or, at least, untaxed) wealth.

Our analysis differs from the existing literature in a number of ways. First, we decompose cash demand into three currency denomination categories to better identify the transactional motive for cash holdings. …

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