The paper Payment Innovations, the Shadow Economy and Cash Demand of Households in Euro Area Countries uses a cointegration framework to understand the drivers of cash demand in the euro-area. Besides the traditional determinants of cash demand like transactions balances and opportunity costs, the authors concentrate on cashless payments media as substitutes to cash payments and the role of the shadow economy. Moreover, they also take due account of country-specific repercussions of the financial and economic crisis of 2008/09, time series properties and distinguish between small and large countries.
The report concludes that cash holdings of euro-area households are driven by:
This implies that the drivers of cash demand are the same, no matter big or small countries, northern or southern countries, countries with an affinity to use cash or those in which consumers predominantly pay cashless or in which there is a policy of restricting the use of cash.
The authors conclude “To ensure a smooth functioning of the cash cycle and the retail payments system, it is important for central banks as well as the commercial banking system to be aware of these developments. This is especially true against the background that the biggest share of cash holdings within the euro area originates from private households.”
The advance of cashless payment methods incentivise people to substitute cash. Consequently, the widespread use of new payments innovations like contactless and mobile payments will further reduce cash holdings (see Brown et al 2020).
It is also common wisdom that every crisis up to now has increased the demand for cash. In this respect, the Covid-19 crisis is special. On the one hand, we saw a decline in transactional demand and a rise of card, especially contactless, payments. On the other side, there was an increase in currency in circulation worldwide, even in Scandinavian countries (e.g., Goodhart & Ashworth, 2020; Chen et al, 2020). The euro area, for example, observed the strongest weekly increase in cash demand ever since its inception, exceeding the previous record in the wake of Lehman crisis in 2008 (Panetta, 2020).
The paper finds that the size of the shadow economy has a strong positive impact on cash demand in the euro area. However, the shadow economy is a construct which, by definition, is hard to capture and to estimate. All in all, it seems that even if cash is used for payments of shadow economic activities, it is probably used to a smaller extent in the context of shadow economic activities than is often suspected and that abolishing or limiting cash would not be as effective as desired in curbing these activities (Mai, 2016; Schneider & Linsbauer, 2016).
All other motives for holding cash were summarized using a (deterministic) trend variable which exerted a positive influence on cash demand in nearly all countries in the sample. Future research should focus on trying to find variables that capture these motives. This would enable to analyze and interpret the cash developments even more precisely and shed more light on the still not so “bright box” of cash demand.