The stabilizing role of cash for societies

Cash – with all its unique characteristics – remains an important pillar of every economy. In fact in recent decades, demand for cash has actually increased steeply, not only on a global scale, but also within advanced economies, including the US, the euro area, and Japan.

Indeed, recent research by economics professors Gerhard Rösl and Franz Seitz shows that cash takes on a particularly important role during periods of economic or societal crisis.¹ Their work explores different types of crises – technological, financial market, natural disaster, inflationary, and political – and reveals two startling consistencies.

In each situation, public demand for cash increased significantly, regardless of the nature of the crisis. However, the nature of the crisis tends to trigger different levels of demand for banknote denominations. In times of cash payment uncertainties there is an increased demand for small denominations; in times of wider financial or general economic uncertainty, when the increased demand for cash is largely the result of consumers building up a store of cash, there is higher demand for large banknote denominations.

The research comes to a fundamental conclusion: even if the use of digital payment has risen in recent years and cash usage has declined at the point of sale, central banks still need to ensure the existence of a well-functioning cash cycle. “Because if it doesn´t work properly in normal times, it certainly won’t function in times of deep uncertainty when demand is consistently high,” emphasizes Professor Rösl.

The persistent appeal of cash

Despite the fast-changing payments landscape, demand for cash is proving highly resilient. What fundamental role does cash continue to play in society that is inspiring that continued demand?

Gerhard Rösl: There is a complete misconception around the scale of the shift to digital. On a global basis, the most important means of payment at the point of sale is still cash. Even in the euro area, payments are still 60% in cash. Of course, there is a large dynamic towards cashless payments, but the growth rate of digital payments should not be mixed up with its relative importance.

Franz Seitz: In the 15 years since the financial crisis, demand for cash has grown enormously, even as digitalization has increased. This is mostly due to the unique characteristics of cash and the fact it is proving very difficult to find a perfect [digital] substitute for it.

Gerhard Rösl: First, cash is very easy to use as a means of payment; everyone understands it, even people with low financial literacy and numeracy. Cash is also final: with cash, you do not have to wait until the money arrives on your bank account – the transaction is completed with the exchange. Cash works in any offline environment, without the need for electricity or a connection to a server. It is available without any additional fees, so you can use it for both small and larger payments. Cash is anonymous. It’s central-bank-issued money, and thus trusted. And it also helps to provide a way of controlling personal spending quite efficiently: when you have to take the money into your hand you are more aware of the sum you are actually paying compared to spending with a payment card.

Franz Seitz: Inclusivity is another important consideration. If you want to have a totally inclusive payment system, then that’s one including cash. All over the word, everybody knows how to handle it, how to use it.

Cash in a time of crisis

Are there other elements that drive people to seek cash as a crisis looms?

Franz Seitz: Certainly, the physical nature of cash plays a role. People like to have something physical in their hand; it makes them feel more comfortable, that they essentially own the value. It’s a factor you cannot overlook in times of crisis. When people start to get worried about the stored value of their money in a bank, they tend to want to withdraw it. It’s the haptics of cash that makes them do so – they want to literally hold the money.

So, the availability of cash in a crisis is important; it calms the situation down. And by increasing the cash supply, central banks have a chance to prevent a domino effect by calming the people with the greatest fear about their cash and stopping its spread at an early point. That’s one central outcome of our research.

Today, the potential [for a domino effect] is even more severe with social media. Imagine a situation when somebody’s bank refuses to let them withdraw cash, how quickly that information can spread over the whole country and create uncertainty and instability. So, it’s really important that you are able to satisfy this demand for cash in a crisis.

This is a completely different argument to the one made in the past: where increased crisis-related cash demand was seen as posing a big problem for bank runs.

Uncertainty is a property of our world and one that has increased in the past few years. And in uncertain times, having a secure and relied-upon payment medium is very important – that’s most of all cash. When you then discuss a digital form of public money, the question is: can the unique characteristics of cash be transferred to a digital form of public money – a central bank digital currency (CBDC)?

So the outcome of our research demonstrates: cash is an anchor for stability within an economy; it is a foundation for a crises-resilient society.

The cash paradox

There seems to be a contradiction here: in many countries cash is less prevalent than it used to be, and yet overall demand is still high. So, are people using cash in different way?

Gerhard Rösl: If cash demand is rising, there must be a different motive for holding cash, which more than compensates for any decline in its use at point of sale due to digital.

This so-called cash paradox became highly observable during the COVID-19 crisis, where it was clear that the increase in cash demand, alongside fully elastic supply of cash by central banks, couldn’t be related to transactional balances.

Because shops were closed, there was little or no possibility to spend cash. So there had to be other motives – in particular, to store value. And in an environment – at the time – of low inflation and near-zero interest rates, cash was a very attractive, highly liquid way to save.

But our analysis shows that the COVID-19 crisis was not the first time this has happened. What we have seen in the past three decades is a change in the role of cash. Its transactional role has decreased and its non-transactional role (as a store of value, hoarding, precautionary measure, whatever you might call it) has increased.

This also shows up in the different role of larger and smaller denominations of banknotes. Look at an example from around the start of the war in Ukraine. In March 2022, Sweden experienced an increase in cash demand that had not been seen in the previous three decades. Why? Because people were afraid that a cyberattack from Russia would shut down electronic means of payment. So, in a country where digital payments dominated, there was suddenly a much higher demand for physical cash.

However, there was a problem: people couldn’t get hold of the larger denomination notes they wanted, specifically the 1,000-krona banknote. That’s because these banknotes weren’t distributed via ATMs and (as in many countries) there were considerably fewer bank branches than in the past. So, in the absence of access to larger denominations, demand for smaller notes increased significantly.

The inevitability of digital cash

How do you see that relationship between physical and digital cash changing with the launch of digital money, in the form of CBDC?

Franz Seitz: We’d forecast that [some major] CBDCs will be issued around the end of this decade, including in the euro area. But there will be a co-circulation; we don’t see any end for physical cash.

Up to now, the central banks all over the world have been focused on the supply side of CBDC. Should it be a retail or wholesale CBDC? Should it be blockchain-based or account-based? Should it be distributed by central banks or by intermediaries? And so on. They need to think more about why the normal citizen should demand a CBDC.

There are actually ways to make CBDC attractive: you can pay interest on it; you can say there are no fees for retailers. But given the current economic circumstances and the arguments of the central banks that they don’t want to interfere with private solutions and don't want to favor one medium against the other, I don’t see really strong arguments for CBDC against the background of well-functioning private payment solutions and the existence of cash.

If you make CBDC very attractive, and push people towards this digital form of public money, it does have the potential to out-compete cash and sight deposits [immediately available bank deposits]. However, we predict that even when issued there will be co-circulation of both forms of central bank money. Indeed, even in countries where there was talk a few years ago of CBDC being substituted for cash, central banks there now only talk of co-circulation.

Gauging the cost – and societal value – of cash

How will the cost of cash – printing cash, distributing it, managing it, and so on – influence its future position?

Franz Seitz: Any analysis of the cost of cash needs to take into account the perspectives of all stakeholders – above all the consumer, but also retailers, banks, card enterprises, cash-in-transit companies, and so on. But it shouldn’t only look at the costs; it has to involve a wider cost-benefit analysis.

Cash works as public insurance. If digital somehow replaced cash altogether then there would obviously be no more cost of cash. But there would still be a cost of no longer having cash around: its absence would have negative consequences for the economy – especially, but not only, in times of uncertainty.

Cash, in itself, is not a public good, but the institution or situation it generates – a more resilient society, a more inclusive society – is. And in the political sphere, cash is increasingly being discussed with respect to resilience. The understanding that having cash on board really helps to create a more resilient society.

Gerhard Rösl: There is also competition perspective. Cash increases the level of competitiveness in the payments market. Of course, it shouldn’t drive out private payments solutions, but it should act as a fallback solution. If everything breaks down, cash still works.

So, there should be a very clear requirement for central banks to ensure sufficient payment infrastructure and a proper cash cycle. What we learned from our research is that, especially in times of crisis, making cash more available is a very efficient way to stabilize the overall situation. Indeed, this might even justify the issuing of higher denominations of banknotes. So the issuing of a €1,000 or €10,000 banknote might be useful as a convenient store of value and a very efficient way to calm down a volatile situation!

Our sincere thanks to Professors Rösl and Seitz for the interview and their great insights!