COVID CASH.

• Author: Rogoff, Kenneth

The advent of the COVID-19 pandemic has witnessed a strong uptick in paper currency demand across advanced economies, even as contactless methods surged ahead of cash in payments. This article explores these two contrasting phenomena, which are in fact continuations of much longer-term trends. The use of cash, while still important for small in-person transactions, has been declining as a share of overall consumer payments for decades, thanks to a steady stream of innovations including credit cards, debit cards, electronic transfers, and smartphone payment apps. For example, in the United States, paper currency accounted for 26 percent of the number of consumer payments in 2019 but only 6 percent in value terms, down from 40 percent and 14 percent, respectively, in 2012. Meanwhile, U.S. dollars in circulation have increased from $1.1 trillion in January 2012 to $1.8 trillion in January 2020, exploding to $2.1 trillion in December 2020. The same pattern remains if one excludes foreign holdings (50-60 percent of the total) and is found in most other advanced economies as well. Some argue that soaring currency demand contests the view that the world is headed to a cashless future, or even a "less-cash" society (see Bech et al. 2018; BIS 2020).

Should strong demand for paper currency be considered an unalloyed benefit in the helicopter money era? Many treasuries and central banks around the world seem to think so. After all, inflation appears to be dormant; the marginal cost of printing a 100 dollar bill to spend is on the order of 20 cents.

In this article, we reexamine this sanguine view of rapid paper currency growth, assessing it from the perspective of the consolidated government balance sheet. Along the lines of other recent studies, we find that the trend decline in interest rates has been a significant factor driving up demand for paper currency (along with high tax rates). Correspondingly, advanced country governments that raise funds by printing currency could do equally well by issuing public debt at extremely low interest rates. Indeed, in Europe and Japan, governments can borrow at negative interest rates, as far out as 30 years in the case of Germany. In such an environment, we argue, the true benefit to issuing paper currency in place of debt is quite small or even negative. This issue has been raised before (e.g., Gross 2016), but there are some subtleties. For example, if converting the entire paper currency supply to 10-year debt were to raise the debt/GDP ratio by, say, 7 percent, what would be the effect on interest rates and the implications for total interest paid on preexisting government debt?

We also consider a way to think about the seigniorage profits to the government from paper currency that considers that a large fraction of cash is held by the underground economy precisely because it is anonymous. Suppose that, instead of buying back the entire stock of paper currency with bond debt, the government creates a central bank digital currency (CBDC) and offers it as an option to anyone tendering paper currency in the buyback. The CBDC can be either a retail version (direct consumer deposits at the central bank) or a two-tier system, where the banking sector continues to intermediate. We conjecture that the demand for non-anonymous CBDC will be considerably less than the preexisting demand for paper currency (perhaps as much as 80 percent less). Given the veiy low interest rate environment, this option turns out to have only a relatively minor effect on the interest savings from issuing currency. But the government (and society) may gain, at the margin, from reduced tax evasion and crime. By this measure, the seigniorage revenues to the government as a whole on paper currency are likely deeply negative, even when interest rates are positive.

Finally, we examine the rationale that issuing paper currency debt might be a better way for the government to hedge against debt distress or future rises in interest rates since paper currency is sometimes viewed as a zero-interest perpetual bond. However, this is quite misleading, since holders of paper currency have a "put" option. Crudely, most governments (including the United States) still accept paper currency for payment of taxes. But much more significantly, paper currency holders have the option of depositing their holdings at a bank, which will end up transforming it to bank reserves, with a maturity of close to zero.

Sharply Rising Cash Holdings and Steadily Declining Transactions Demand

We begin by exploring what is known about use of cash, the growing cash in transactions (as opposed to hoarding), and how the total demand for paper currency--including both hoarding and payments--varies across countries. Of course, precisely because cash is anonymous, usage is difficult to track, and direct evidence is thin. Most of what is known comes from central bank surveys that are very limited in scope and number.

However, although direct data on cash usage in payments is sparse, there is extensive information on other payment media such as bank cards and electronic payments. Across countries, the value of these payment alternatives consistently has been growing significantly faster than consumption. This will allow us to infer with a veiy high probability that the use of cash in payments is steadily declining, with debit cards encroaching even on small retail payments, the last area (of legal, tax-compliant) transactions where cash remains king.

Currency Demand during COVID-19

Overall currency demand has soared after the COVID-19 shock in 2020, even more than after the financial crisis. For example, for the United States, currency in circulation rose by 9.5 percent in the 12 months between September 2008 and September 2009. But it rose by 12.5 percent in the 10 months from March 2020 to November 2020. This is all the more remarkable given that during 2008, cash demand was stoked in part by sharply lower interest rates, whereas interest rates were already at very low (or negative) levels at the outset of the COVID-19 shock.

Figure 1 illustrates the rise in currency in circulation as a share of GDP for the major advanced economies from 2000 to the present.

In the United States, currency in circulation rose by $276 billion (15.4 percent) in 2020, in Europe by [euro]142 billion (11.0 percent), and in Japan by [yen]5.69 trillion (4.8 percent). As Figure 2 illustrates, similarly sharp rises in currency demand in 2020 were also seen in smaller advanced economies, as well as the longer-term rise. As Table 1 illustrates for the United States, the Euro Area, Japan, and a set of smaller advanced economies, the bulk of the advanced economy currency supply is in large-denomination notes such as the $100 bill, as has long been the case (see Rogoff 1998, 2016).

Cross-Country Evidence on Determinants of Overall Currency Demand

Was the sharp rise in currency demand during Covad-19 mainly due to lower interest rates or was there a clear structural break in demand? Table 2 presents suggestive simple regressions of currency demand across a range of advanced economies, using government bond interest rates. In an appendix (available online), we show that similar results hold for the core regressions using monetary policy rates or deposit rates. (1) Both the interest rate and the tax/GDP ratio enter significantly across the regressions. (2) Interestingly, if we separate out demand between large bills and lower-denomination notes, the interest rate is significant only lor the large bills.

Although one should be careful in interpreting these numbers, we note that from Table 2, in the baseline regression with the government bond interest rate and tax/GDP, the roughly 4 percent average drop in 10-year Treasury nominal interest rates since 2000 can account for a roughly 2.5 percent increase (4 * 0.64) increase in currency to GDP ratios. (3)

The Transactions Component to the Demand for Cash

Anonymity is a key feature of paper currency, and, although in principle it would be possible obtain retail transactions data from cash...