The benefits of cash

Costs and benefits of cash and cashless payment instruments (Module 2)
Knapp, Fritz (Verlag)
  • 1. Auflage
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  • erschienen am 4. August 2017
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  • 104 Seiten
E-Book | ePUB mit Wasserzeichen-DRM | Systemvoraussetzungen
978-3-8314-0883-2 (ISBN)
Cash is an exciting and important topic, which has become the subject of extensive debate, especially of late. Cash is also the frequent target of criticism, with claims that it is inefficient, expensive, fosters the shadow economy and impairs the effect of monetary policy measures. Yet despite all of this criticism and the discussion over its future, at just under 80% of all point-of-sale transactions, cash remains the most significant means of payment for the German population.

An analysis in which the costs and benefits of cash are considered on an equal footing is an essential foundation for a factual discussion about cash. While much attention is paid to the cost aspects, the benefits of cash are usually given less consideration in the relevant literature. This state of affairs led the Bundesbank to commission an external study analysing payment instruments in Germany - with a particular focus on cash payments - and evaluating their associated costs and benefits. The first part of the study, "Overview and initial estimates", published in 2014, provides a critical overview of the literature on cost calculations and the significance of payment transactions in various countries. This module also provides an independent account of the importance and cost of cash and cashless payment instruments for the national economy. This second module of the study focuses especially on the benefits of cash. The authors describe the microeconomic, macroeconomic and societal benefits of cash. Against this backdrop, this study attempts to systematically capture the benefits, without providing a quantitative assessment. In addition, it goes into explicit detail about the aforementioned arguments put forward by critics of cash as well as the drawbacks and consequences of abolishing cash. To achieve an overall picture of the costs and benefits of cash, the costs generated by the use of cash are to be quantified in the study's planned third module.
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Malte Krueger is Professor of Economics at the University of Applied Sciences in Aschaffenburg (Germany). He has worked as a research fellow for a number of institutions, inter alia, the Bank of Spain, the University of Western Ontario, and the European Commission. For many years he has also been a consultant for PaySys Consultancy (Frankfurt) with a focus on card payments. Academic research has mainly addressed cash and cash-less payments, two-sided markets, monetary economics and exchange rates. Currently, he works on a Bundesbank project on the costs and benefits of cash.

Professor Franz Seitz teaches Economics with a special focus on Monetary Policy and Financial Markets at Weiden Technical University of Applied Sciences. He is also one of the leading members of the "Aktionskreis: Stabiles Geld". Before his professorship, he worked at the Deutsche Bundesbank in the division Money, Credit and Capital Markets. Professor Seitz is author of numerous articles in national and international journals. His textbook "European Monetary Policy: Theory, empirical applications and practice" ("Europäische Geldpolitik: Theorie, Empirie und Praxis") has become a standard book in German speaking countries. Additionally, one research focus is the payment system and cash in circulation. For many years now, Professor Seitz is acting as a consultant in different projects together with the Deutsche Bundesbank and the European Central Bank.

1 Introduction and overview

2 Benefits of cash: an overview of the literature

3 Some general remarks

4 Macroeconomic benefits
4.1 Implications for monetary policy
4.2 Role of cash in financial crises
4.3 Consequences for a two-stage banking system (A bank is where the money is)
4.4 Special role of foreign holdings
4.5 Seigniorage

5 Microeconomic benefits
5.1 Payment behaviour, risk and technology
5.1.1 The problem
5.1.2 Data and definition of variables
5.1.3 Results
5.1.4 Interpretation and classification of the results
5.2 Overview and control of spending
5.3 Lower income groups and cash (payments inclusion)
5.4 Data protection and privacy
5.5 A potential electronic substitute for cash

6 Societal benefit
6.1 Fall-back solution for cashless payments
6.2 Independence of foreign card providers
6.3 Benchmark for card fees
6.4 Alternative to a narrow oligopoly
6.5 Welfare aspects of cash

7 Criticism of cash
7.1 The shadow economy argument
7.2 The monetary policy argument
7.3 The speed argument and security aspects
7.4 Search for efficient prices
7.5 Possible disruptions to the cash supply

8 Summary, conclusions



4Macroeconomic benefits

4.1Implications for monetary policy

Turning to the role played by cash in monetary policy, this section focuses mainly on the more traditional arguments that are put forward in favour of cash. Section 7.2 explicitly examines the debate that has only recently taken centre stage concerning aspects of the effective implementation of negative interest rates.

Cash (meaning banknotes) is a key item on the liabilities side of a central bank's balance sheet. Totalling more than ? 1.1 trillion, banknotes accounted for around 40% of the Eurosystem's consolidated balance sheet total at the end of 2016. It follows that, in a world without cash (and ceteris paribus), central bank balances sheets would become considerably shorter. This is especially true of the Eurosystem's balance sheet and that of the Federal Reserve System, not least because substantial cash holdings of US dollar and euro are held abroad. Hence, central banks would hold fewer interest-bearing assets and their profits would be smaller than today.10 Central banks might then prove unable to generate sufficient earnings to cover their own costs, thus making them dependent on grants from their respective government. Given the current level of reserves, this scenario seems unlikely, but it should still be noted that prior to the various crisis periods, when banks had next to no excess reserves, the relative significance of cash was much greater. At all events, the level of profit distributions paid to governments would probably decline, potentially jeopardising central bank independence. Moreover, the modest size of the balance sheet could cause problems in cases where extensive restrictive (liquidity-absorbing) measures cannot be carried out.

In a world where cash payments were subject to restrictions and obstacles, market participants would take avoidance action. The demand for foreign currencies would increase and private (in)official means of payment such as bitcoins, vouchers, regional currencies (eg the "Chiemgauer", used in Prien am Chiemsee in Bavaria), trade bills, cheques etc would flourish (again) and undergo a new wave of development. This would make it harder for the central bank to control the overall money stock (see ECB, 2015 b).

Monetary theory usually postulates that a central bank uses its control over the availability of central bank money (ie over banks' liquidity or reserves) or its pivotal role in setting the short-term interest rate to indirectly influence price developments. In actual practice, a short-term interest rate is the preferred operational target (see Görgens et al, 2014, section III.4). This implies the use of a precisely specified range of monetary policy measures for achieving price stability, in turn entailing a precisely defined volume of central bank money and monetary aggregates (see Nelson, 2008, 1805). So long as legal tender issued exclusively by the central bank in the form of cash continues to exist, there will be an institution in place that - assuming credibility - cares about nominal variables such as the money stock and price developments, thus solving the indeterminacy problem with respect to the price level (see Costa Storti & de Grauwe, 2001).

But how would this process unfold in a cashless world? Let us start by assuming that money consists solely of deposits issued by banks, with no reserves being held at the central bank and the unit of account is set by the government with respect to the domestic currency (eg euro).11 Since the possibilities for money creation available to (profit-maximizing) banks would not be constrained by cash withdrawals or minimum reserves, the acquisition of assets (as counterparts to deposits, eg shares, bonds, lending) would also be unconstrained. Monetary developments as well as asset and price developments would therefore be indeterminate (see Costa Storti & de Grauwe, 2001, section 2).12 Introducing minimum reserve requirements, issuing electronic central bank money or strengthening the supervisory role of the central bank are all steps that could counterbalance this effect.

Under the prevailing system, there is a demand on the part of banks for reserves at the central bank as a way to obtain cash or due to voluntary or mandatory reserve holdings. A connection evolves between the commercial banking system and the central bank, inter alia through cash. This gives rise to a demand for central bank money, which, in turn, is needed for the operational management of the overnight rate. And cash accounts for the lion's share of central bank money (monetary base). In terms of central banks' liquidity management, this component represents an autonomous factor, normally following an upward trend with a seasonal weekly, monthly and annual pattern. These regularities make it possible to forecast the evolution of banknotes with relative ease when managing liquidity (with regard to the Eurosystem, see Camba-Mendez et al, 2009).

Schreft & Smith (2000) investigate the repercussions of a decline in the demand for cash for transaction purposes on the efficacy of different monetary policy strategies (inflation targeting, money targeting etc). They conclude that, in a world of positive interest rates, all strategies can, in principle, be implemented using conventional open market operations. This does not necessarily hold in an economy with zero interest rates as in such an environment there are no incentives to economize on holdings of cash.

Cash represents only one monetary component. However, it responds the most to interest rate changes (inasmuch as it does not carry any interest) and is therefore, inter alia, responsible for the negative interest elasticity of monetary aggregates. Since one transmission channel of monetary policy to the financial system and the real economy is via influencing monetary developments through interest rate changes, cash is useful in this respect. In Germany, this applies mainly to large and medium denominations (Bartzsch & Seitz, 2016). The interest elasticity of cash demand probably also hinges on the specific features of alternative means of payment. Briglevics & Schuh (2014) show that, in the United States, interest elasticity declined in absolute terms on account of the increase in the number of individuals using credit cards on a revolving basis (revolvers), compared to "convenience users", who pay off their credit balance at the end of each billing period.13 Given that most users in Germany belong to the latter category, the more interest-elastic response seems plausible.

Since cash is closely related to private sector expenditures, cash-related variables or narrow monetary aggregates with a high share of cash are good indicators of real activity (see Albuquerque et al, 2016, for the United States, and Brand et al, 2004, as well as Boysen Hogrefe, 2012, for the euro area). As data on monetary aggregates and, specifically, on cash in circulation are available without a long time-lag and with high precision, and since economic activity is carefully monitored by central banks, attention should be paid to cash developments in this context.

Adopting a more general and long-term monetary policy perspective, a crucial question to ask is how the monetary system would be transformed if cash as central bank money were abolished. It is hardly likely that bank deposits would be declared legal tender. Therefore, central banks would probably have little choice but to grant access to electronic central bank money to everyone (see Section 4.3 for details).

4.2Role of cash in financial crises

One aspect that is sometimes overlooked is the role played by cash in times of crisis. As a general rule, the demand for cash rises in the wake of a financial crisis (see the situation following the collapse of Lehman Brothers, or events in Greece in 2015). Such a run on banks is usually viewed as a threat to the financial system. Conversely, however, it is also true that bank customers are greatly relieved to recognize that they actually can access "their money" (Negueruela, 2014).14 In a system in which only electronic money exists, it would be virtually impossible for non-banks to withdraw funds from the banking system on a broad basis in the event of a crisis of confidence. Some people could of course reduce their bank deposits by acquiring assets from other economic agents. However, this would push up the level of bank deposits held by the sellers, thus confronting them with the problem of having to acquire assets with these increased bank deposits ("hot potato effect"). This could, in turn, result in sharp fluctuations in financial market prices, which would probably exacerbate the crisis. What is more, in case electronic payments were to be interrupted (due to technical disruptions, strikes, etc), cash could still be used to execute certain payments. In a purely electronic system, it is possible that no payments could be made at all. During such periods of crisis, cash would serve as a transaction medium and a medium of exchange as well as store of value of last resort. In the case of a currency for which there is also an international demand, such as the euro or the US dollar, this function of cash applies to both domestic and foreign demand. Its status as legal tender and the fact that it is issued exclusively by the central bank are also helpful...

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