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Cash Is Alive: How Economists Explain Cash Usage and Holding

Categories : Cash and Crises, Cash covers a broad range of transactions, Cash does not require a technology infrastructure, Cash enables an immediate transfer of value, Cash protects privacy and anonymity, Costs of cash versus costs of electronic payment instruments
February 24, 2023
Tags : Cash demand, Cash substitution, cost of cash, Privacy and anonymity
A comprehensive review of economic research on cash usage and consumer holdings concludes cash is alive and well.
Guillaume Lepecq

This post is also available in: Spanish

Oz Shy, Senior Policy Advisor and Economist at the Federal Reserve Bank of Atlanta, has compiled a spectacularly comprehensive literature review on consumer demand for cash covering 271 papers. Its publication in the Journal of Economic Literature is forthcoming. “Why is economic research on cash needed?” asks Shy. “A short and simple answer to this question is that cash does not seem to be going away.”

Shy has been doing research on payment methods for 20 years. “When we started, we were convinced that cash was about to disappear in a few years, primarily because of the emergence of electronic cash cards […] We were wrong! Cash continues to be alive and is actually doing well in most countries.”

The Unique Features of Cash

One key conclusion is that the use of cash has been declining as a payment instrument. Still, demand for cash holding and storing has been increasing. Nonetheless, cash is still heavily used as a payment method.

The report identifies seven unique features that make cash different from other payment instruments:

  1. Cash circulates for free.
  2. Cash can be transferred between buyers and sellers in both directions.
  3. Cash provides immediate and final settlements with no intermediaries.
  4. Cash preserves the anonymity of users.
  5. Cash works offline.
  6. Cash does not require a bank account.
  7. Cash is widely accepted.

Transactional vs. Store of Value Demand

The reviewed research unanimously shows that most cash in circulation is held as a store of value, either domestically or overseas. The higher growth of large-denomination notes evidences this was mainly a store of value compared to low-denominations used for transactional purposes.

Numerous factors explain the preference for holding cash, including low-interest rates and lack of trust in banks, compounded with economic and political uncertainty. However, several policies which have driven up the cost of holding cash have been justified by the aim of  reducing money laundering and combating the shadow economy:

Characteristics of Cash Payments

The value of the transaction is the essential characteristic impacting the decision to pay in cash. One study shows that in the U.S., 80% of payments below $1 are made in cash; the ratio drops to 60% for payments below $5 and 40% for those below $10.

The paper also analyses the impact of price incentives on how people pay. It concludes that when merchants pass on to consumers the costs of debit or credit cards, with surcharging fees, they steer them towards cash. On the other hand, when card issuers incentivize consumers to pay by card with cashback and loyalty points, they drive them away from cash.

When merchants charge the same price regardless of how consumers pay, they may incorporate some of the costs they bear for receiving credit card payments into their prices. As a result, consumers who pay with cash subsidize those who pay with cards. Credit card spending is positively associated with household income, resulting in a regressive transfer from low-income to high-income households.

The report cites a study (Schuh, Shy, Stavins 2010) that finds that, on average, each cash-using household pays $149 to card-using families. Each card-using home receives $1,133 from cash users every year.

Can Cash be Substituted?

“[…] All the predictions made in the past about the “end of cash” turned out to be wrong. Why is that? There are several reasons, mainly on the demand side, such as the direct benefits consumers derive from perfect anonymity, immediate settlement, offline functionality, and easy budgeting.” writes Shy. He adds that privacy is an essential and unique feature of cash.

Another barrier is what Shy calls the funding issue, also known as the problem of the last mile. Digital payments are funded, in most cases, by money, which is transferred from a bank account; this means that users require a bank account but also that a new payment instrument enters into a competition with existing digital options rather than with cash. M-Pesa, the mobile money system launched in Kenya in 2008, is one counterexample. It does not require transfers from a bank account but relies on a very dense network of agents who transfer cash into mobile money and mobile money into cash.

This is probably a valuable lesson for countries investigating Central Bank Digital Currencies. The Bahamas’ Sand Dollar, launched in 2020, can be funded without a bank account.

“Other reasons for why cash will likely remain a payment method include climate change, natural disasters, economic and political instability, and wars in some parts of the world. In all these cases the supply of electricity and transmission of mobile phone signals are not guaranteed.” concludes Shy.

This post is also available in: Spanish