Oz Shy, Senior Policy Advisor and Economist at the Federal Reserve BankSee Central bank. More of Atlanta, has compiled a spectacularly comprehensive literature review on consumer demand for cashMoney in physical form such as banknotes and coins. More 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 paymentA transfer of funds which discharges an obligation on the part of a payer vis-à-vis a payee. More 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.”
One key conclusion is that the use of cash has been declining as a payment instrumentDevice, tool, procedure or system used to make a transaction or settle a debt. More. Still, demand for cash holding and storing has been increasing. Nonetheless, cash is still heavily used as a payment methodSee Payment instrument. More.
The report identifies seven unique features that make cash different from other payment instruments:
The reviewed research unanimously shows that most cash in circulationThe value (or number of units) of the banknotes and coins in circulation within an economy. Cash in circulation is included in the M1 monetary aggregate and comprises only the banknotes and coins in circulation outside the Monetary Financial Institutions (MFI), as stated in the consolidated balance sheet of the MFIs, which means that the cash issued and held by the MFIs has been subtracted (“cash reserves”). Cash in circulation does not include the balance of the central bank’s own banknot... More 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 launderingThe operation of attempting to disguise a set of fraudulently or criminally obtained funds as legal, in operations undeclared to tax authorities, and therefore not subjected to taxation. Money laundering activities are strongly pursued by authorities and in most countries, there are strict rules for credit institutions to cooperate in the fight against money laundering operations, to declare and report any transactions that could be considered suspicious. More and combating the shadow economy:
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 paperSee Banknote paper. More 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 cashbackA service whereby the customer pays electronically a higher amount to a retailer than the value of the purchase for goods and/or services and receives the difference in cash. It is also a reward system associated with credit card usage, whereby the consumer receives a percentage of the amount spent on the credit card. More 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.
“[…] 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 settlementThe discharge of an obligation in accordance with the terms of the underlying contract. In e-transfers the settlement may take days, whereas cash settlements are instantaneous and irreversible. More, 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 moneyFrom the Latin word moneta, nickname that was given by Romans to the goddess Juno because there was a minting workshop next to her temple. Money is any item that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular region, country or socio-economic context. Its onset dates back to the origins of humanity and its physical representation has taken on very varied forms until the appearance of metal coins. The banknote, a typical representati... More, 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 DollarMonetary unit of the United States of America, and a number of other countries e.g. Australia, Canada and New Zealand. More, 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.