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CBDC and Cash in the Euro Area: Crowding Out or Co-Circulation?

Categories : Cash is the most widely used payment instrument, Costs of cash versus costs of electronic payment instruments
November 25, 2022
A new paper explores the current role of cash and the probable design of a future Central Bank Digital Currency (CBDC) in the euro area, the digital euro. It asks if there is a possible crowding out of cash by the digital euro or, more likely a co-circulation.
Guillaume Lepecq

Chair, CashEssentials

This post is also available in: Spanish

Gerhard Rösl and Franz Seitz investigate how the digital euro could coexist alongside banknotes and coins.

Demand for Cash Remains Strong

Cash usage at the point of sale decreased perceptibly in the past years. This is partly due to the ongoing trend towards digitalization. Still, there are indications that consumers were nudged towards digital payments by government regulations and supply-side restrictions by commercial banks. Nonetheless, overall demand for euro cash remained strong and even increased relative to GDP since the financial crisis in 2008.

However, Figure 1 illustrates that small denominations (€ 5- € 20) have been remarkably stable in GDP terms, at around 0.9%, indicating steady transactional demand for cash. By contrast, large denominations have increased approximately four times faster than GDP and have reacted positively to crises such as the Global Financial Crisis or the Covid-19 pandemic.

Fig. 1. Small (€5 – €20) and large (€50 – €500) euro banknote denominations in circulation in % of nominal GDP (2002 – 2021)

Central banks worldwide are considering the potential issue of a Central Bank Digital Currency as a substitute or complement to cash. Although the characteristics of a possible digital euro have become more perceptible, its fundamental design properties remain unknown. Rösl and Seitz categorise different types of money (Table 1) currently circulating in the euro area and look at how a CBDC would fit.

A Digital Euro Will Not Match the Attributes of a Cash

According to the latest survey by the Bank for International Settlement, 90% of 80 surveyed central banks are currently engaged in CBDC work, mainly focusing on retail CBDC as a cash-like claim on the central bank, but where the private sector handles all customer-facing activities (Kosse/Mattei 2022). Rösl and Seitz emphasize that although the ECB explicitly keeps all design options open, there are signals that a digital euro will not match some of the critical attributes of cash.

Firstly, it should not be used as a saving instrument (Panetta 2022b). For that reason and to avoid systemic risks from a possible flight into CBDC in times of financial crisis, individual holdings of digital euros will be either limited or indirectly restricted by tiered remuneration.

Secondly, the digital euro will not offer the same complete anonymity as cash. Money holders will be required to identify themselves when they purchase digital euros, preferably at a supervised intermediary such as a commercial bank.

Thirdly, it is unclear whether there will be sufficient demand for the digital euro. But given the information currently available, there seems to be little interest in the new digital money by consumers who want to pay anonymously. These people will likely continue using cash for at least as long as supply-side restrictions by commercial banks and government limitations on cash usage will not intensify. A 2022 survey by the Austrian central bank showed that two-thirds of respondents had never heard of a digital euro. Most respondents wanted cash to keep an essential role in the future.

In conclusion, Rösl and Seitz stress that cash is far from being outdated as domestic and foreign residents continuously seek euro banknotes as a highly liquid store of value. Around 80% of total euro cash in circulation is not used for domestic transactional purposes.

“It is very hard to predict what role a digital euro will play in the future payment markets. Our guess, however, is that there will be a co-circulation with cash in the coming decades.” Gerhard Rösl and Franz Seitz

The final decision to introduce or not the digital euro will not be taken before autumn 2023.

This post is also available in: Spanish