5 June 2014 – Monetary policy decisions
At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
The interest rate on the main refinancing operations of the
Eurosystem will be decreased by 10 basis points to 0.15%, starting from
the operation to be settled on 11 June 2014.
The interest rate on the marginal lending facility will be decreased
by 35 basis points to 0.40%, with effect from 11 June 2014.
The interest rate on the deposit facility will be decreased by
10 basis points to -0.10%, with effect from 11 June 2014. A separate
press release to be published at 3.30 p.m. CET today will provide
details on the implementation of the negative deposit facility rate.
The President of the ECB will comment on the considerations
underlying these decisions at a press conference starting at 2.30 p.m.
CET today. Further monetary policy measures to enhance the functioning
of the monetary policy transmission mechanism will be communicated in a
press release to be published at 3.30 p.m. CET today.
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In USA and Europe as in Cypern ?
Eliminate cash to push negative interests to rob savings from honest citizen to help banksters as in Cypern.
Cypriots rushed to A.T.M.’s to remove their savings
Depositors are faced with mainstream
reports like this in the New York Times:
In a move that could set off new fears of contagion across the euro
zone, anxious depositors drained cash from automated teller machines in
the weekend, hours after European officials in Brussels required that
part of a new €10 billion bailout be paid for directly from the bank
The decision—a first in the three-year-old European financial
crisis—raised questions about whether bank runs could be set off
elsewhere in the euro
zone. Jeroen Dijsselbloem, the president of the group of euro area
ministers, declined Saturday to rule out taxes on depositors in
countries beyond Cyprus,
although he said such a measure was not currently being considered.
comments from European finance officials:
“A rescue programme agreed for Cyprus on Monday represents a new
template for resolving euro zone banking problems and other countries
may have to
restructure their banking sectors,” the head of the region’s finance
“What we’ve done last night is what I call pushing back the risks,”
Dutch Finance Minister Jeroen Dijsselbloem, who heads the Eurogroup of
finance ministers, told Reuters and the Financial Times hours after the Cyprus deal was struck.
“If there is a risk in a bank, our first question should be ‘Okay, what
are you in the bank going to do about that? What can you do to
yourself?’ If the bank can’t do it, then we’ll talk to the shareholders
and the bondholders, we’ll ask them to contribute in recapitalising the
if necessary the uninsured deposit holders,” he said.
Introductory statement to the press conference
Mario Draghi, President of the ECB,
Frankfurt am Main, 5 June 2014
Ladies and gentlemen, the Vice-President and I are very pleased to
welcome you to our press conference. We will now report on the outcome
of today’s meeting of the Governing Council, which was also attended by
the Commission Vice-President, Mr Rehn.
In pursuing our price stability mandate, today we decided on a
combination of measures to provide additional monetary policy
accommodation and to support lending to the real economy. This package
includes further reductions in the key ECB interest rates, targeted
longer-term refinancing operations, preparatory work related to outright
purchases of asset-backed securities and a prolongation of fixed rate,
full allotment tender procedures. In addition, we have decided to
suspend the weekly fine-tuning operation sterilising the liquidity
injected under the Securities Markets Programme.
The decisions are based on our economic analysis, taking into account
the latest macroeconomic projections by Eurosystem staff, and the
signals coming from the monetary analysis. Together, the measures will
contribute to a return of inflation rates to levels closer to 2%.
Inflation expectations for the euro area over the medium to long term
continue to be firmly anchored in line with our aim of maintaining
inflation rates below, but close to, 2%. Looking ahead, the Governing
Council is strongly determined to safeguard this anchoring. Concerning
our forward guidance, the key ECB interest rates will remain at present
levels for an extended period of time in view of the current outlook for
inflation. This expectation is further underpinned by our decisions
today. Moreover, if required, we will act swiftly with further monetary
policy easing. The Governing Council is unanimous in its commitment to
using also unconventional instruments within its mandate should it
become necessary to further address risks of too prolonged a period of
Let me now briefly describe the individual measures decided today.
Further details will be published at 3.30 p.m. on the ECB’s website.
First, we decided to lower the
interest rate on the main refinancing operations of the
Eurosystem by 10 basis points to 0.15% and the rate on the marginal
lending facility by 35 basis points to 0.40%. The rate on the deposit
facility was lowered by 10 basis points to -0.10%. These changes will
come into effect on 11 June 2014. The negative rate will also apply to
reserve holdings in excess of the minimum reserve requirements and
certain other deposits held with the Eurosystem.
Second, in order to support bank lending to households and
non-financial corporations, excluding loans to households for house
purchase, we will be conducting a series of
targeted longer-term refinancing operations (TLTROs).
All TLTROs will mature in September 2018, i.e. in around 4 years.
Counterparties will be entitled to borrow, initially, 7% of the total
amount of their loans to the euro area non-financial private sector,
excluding loans to households for house purchase, outstanding on 30
April 2014. Lending to the public sector will not be considered in this
calculation. The combined initial entitlement amounts to some €400
billion. To that effect, two successive TLTROs will be conducted in
September and December 2014. In addition, from March 2015 to June 2016,
all counterparties will be able to borrow, quarterly, up to three times
the amount of their net lending to the euro area non-financial private
sector, excluding loans to households for house purchase, over a
specific period in excess of a specified benchmark. Net lending will be
measured in terms of new loans minus redemptions. Loan sales,
securitisations and write-downs do not affect the net lending measure.
The interest rate on the TLTROs will be fixed over the life of each
operation, at the rate on the Eurosystem’s main refinancing operations
(MROs) prevailing at the time of take-up, plus a fixed spread of 10
basis points. Starting 24 months after each TLTRO, counterparties will
have the option to make repayments. A number of provisions will aim to
ensure that the funds support the real economy. Those counterparties
that have not fulfilled certain conditions regarding the volume of their
net lending to the real economy will be required to pay back borrowings
in September 2016.
In addition, the Governing Council decided to extend the existing
eligibility of additional assets as collateral, notably under the
additional credit claims framework, at least until September 2018.
Third, the Governing Council decided to intensify preparatory work related to outright purchases in the
ABS market to enhance the functioning of the monetary
policy transmission mechanism. Under this initiative, the Eurosystem
will consider purchasing simple and transparent asset-backed securities
with underlying assets consisting of claims against the euro area
non-financial private sector, taking into account the desirable changes
in the regulatory environment, and will work with other relevant
institutions to that effect.
Fourth, in line with our forward guidance and our determination to
maintain a high degree of monetary accommodation, as well as to contain
volatility in money markets, we decided to continue conducting the MROs
fixed rate tender procedures with full allotment for as
long as necessary, and at least until the end of the reserve
maintenance period ending in December 2016. Furthermore, we decided to
conduct the three-month longer-term refinancing operations (LTROs) to be
allotted before the end of the reserve maintenance period ending in
December 2016 as fixed rate tender procedures with full allotment. The
rates in these three-month operations will be fixed at the average rate
of the MROs over the life of the respective LTRO. In addition, we
decided to suspend the weekly fine-tuning operation sterilising the
liquidity injected under the Securities Markets Programme.
Let me now explain our assessment in greater detail, starting with the
economic analysis. Real GDP in the euro area rose by
0.2%, quarter on quarter, in the first quarter of this year. This
confirmed the ongoing gradual recovery, while the outcome was somewhat
weaker than expected. Most recent survey results signal moderate growth
also in the second quarter of 2014. Looking ahead, domestic demand
should continue to be supported by a number of factors, including the
accommodative monetary policy stance, ongoing improvements in financing
conditions working their way through to the real economy, the progress
made in fiscal consolidation and structural reforms, and gains in real
disposable income resulting from falls in energy prices. At the same
time, although labour markets have shown some further signs of
improvement, unemployment remains high in the euro area and, overall,
unutilised capacity continues to be sizeable. Moreover, the annual rate
of change of MFI loans to the private sector remained negative in April
and the necessary balance sheet adjustments in the public and private
sectors are likely to continue to weigh on the pace of the economic
This assessment of a moderate recovery is also reflected in the June
2014 Eurosystem staff macroeconomic projections for the euro area, which
foresee annual real GDP increasing by 1.0% in 2014, 1.7% in 2015 and
1.8% in 2016. Compared with the March 2014 ECB staff macroeconomic
projections, the projection for real GDP growth for 2014 has been
revised downwards and the projection for 2015 has been revised upwards.
The risks surrounding the economic outlook for the euro area continue
to be on the downside. Geopolitical risks, as well as developments in
emerging market economies and global financial markets, may have the
potential to affect economic conditions negatively. Other downside risks
include weaker than expected domestic demand and insufficient
implementation of structural reforms in euro area countries, as well as
weaker export growth.
According to Eurostat’s flash estimate, euro area annual HICP
inflation was 0.5% in May 2014, after 0.7% in April. This outcome was
lower than expected. On the basis of the information available to us at
today’s meeting, annual HICP inflation is expected to remain at low
levels over the coming months, before increasing only gradually during
2015 and 2016, thereby underpinning the case for today’s decisions.
Meanwhile, inflation expectations for the euro area over the medium to
long term continue to be firmly anchored in line with our aim of
maintaining inflation rates below, but close to, 2%. Looking ahead, the
Governing Council is strongly determined to safeguard this anchoring.
Our assessment has been supported by the June 2014 Eurosystem staff
macroeconomic projections for the euro area. They foresee annual HICP
inflation at 0.7% in 2014, 1.1% in 2015 and 1.4% in 2016. In the last
quarter of 2016, annual HICP inflation is projected to be 1.5%. In
comparison with the March 2014 ECB staff macroeconomic projections, the
projections for inflation for 2014, 2015 and 2016 have been revised
downwards. It should be stressed that the projections are conditional on
a number of technical assumptions, including exchange rates and oil
prices, and that the uncertainty surrounding each projection increases
with the length of the projection horizon.
The Governing Council sees both upside and downside risks to the
outlook for price developments as limited and broadly balanced over the
medium term. In this context, we will closely monitor the possible
repercussions of geopolitical risks and exchange rate developments.
Turning to the
monetary analysis, data for April 2014 continue to
point to subdued underlying growth in broad money (M3). Annual growth in
M3 moderated further to 0.8% in April, from 1.0% in March. The growth
of the narrow monetary aggregate M1 moderated to 5.2 % in April, after
5.6% in March. In the recent past, the increase in the MFI net external
asset position, reflecting in part the continued interest of
international investors in euro area assets, has been the main factor
supporting annual M3 growth.
The annual rate of change of loans to non-financial corporations
(adjusted for loan sales and securitisation) was -2.7% in April 2014,
compared with -3.1% in March. Weak loan dynamics for non-financial
corporations continue to reflect their lagged relationship with the
business cycle, credit risk and the ongoing adjustment of financial and
non-financial sector balance sheets. The annual growth rate of loans to
households (adjusted for loan sales and securitisation) was 0.4% in
April 2014, broadly unchanged since the beginning of 2013.
To sum up, a
cross-check of the outcome of the economic analysis
with the signals coming from the monetary analysis led the Governing
Council to decide on a combination of measures to provide further
monetary policy accommodation and to support lending to the real
In order to strengthen the economic recovery, banks and policy-makers
in the euro area must step up their efforts. Against the background of
weak credit growth, the ongoing comprehensive assessment of banks’
balance sheets is of key importance. Banks should take full advantage of
this exercise to improve their capital and solvency position, thereby
contributing to overcome any existing credit supply restriction that
could hamper the recovery. At the same time, policy-makers in the euro
area should push ahead in the areas of fiscal policies and structural
fiscal policies, the Eurosystem staff macroeconomic
projections indicate continued progress in restoring sound public
finances in the euro area. The aggregate euro area general government
deficit is projected to decline gradually from 3.0% of GDP in 2013 to
2.5% of GDP in 2014. For 2015 and 2016, a further decline to 2.3% and
%, respectively, is projected. General government debt
is projected to peak at 93.4% of GDP this year. Thereafter, it is
projected to decline, reaching around 91% in 2016. As regards
structural reforms, important steps have been taken to
increase the competitiveness and the adjustment capacity of countries’
labour and product markets, although progress has been uneven and is far
from complete. In this context, the Governing Council takes note of the
European Commission’s recommendations on fiscal and structural
policies, published on 2 June 2014, to continue the path of reducing
budgetary and macroeconomic imbalances. The recommendation to the
Council to abrogate the excessive deficit procedures for four euro area
countries indicates continued progress in restoring sound public
finances. However, euro area countries should not unravel progress made
with fiscal consolidation. A full and consistent implementation of the
euro area’s macroeconomic surveillance framework, together with the
necessary policy actions by euro area countries, will help to raise
potential growth, increase the euro area’s resilience to shocks and
facilitate job creation.
We are now at your disposal for questions.
Costs and Benefits to Phasing Out Paper Currency
advances in transactions technologies, paper currency still constitutes
a notable percentage of the money supply in most countries. For
example, it constitutes roughly 10% of the US Federal Reserve’s main
monetary aggregate, M2. Yet, it has important drawbacks. First, it can
help facilitate activity in the underground (tax-evading) and illegal
economy. Second, its existence creates the artifact of the zero bound on
the nominal interest rate. On the other hand, the enduring popularity
of paper currency generates many benefits, including substantial
seigniorage revenue. This paper explores some of the issues associated
with phasing out paper currency, especially large-denomination notes.
NBER Working Paper 20126
Presented at NBER Macroeconomics Annual Conference, April 11, 2014
This version May 5, 2014
Costs and benefits to phasing out paper currency
By Kenneth Rogoff1, Harvard University
This paper explores the costs and benefits to phasing out paper currency, beginning with large-denomination notes, later extending to all but small coins and bills, and eventually those as well. It is hardly a simple issue; paper currency is deeply ingrained in the public’s image of government and country, and any attempt to change long-standing monetary conventions raises a host of complex issues. The symbolic value of the euro, for example, as a flag for nascent European Institutions, is hard to overstate. Nevertheless, it is important to ask whether currency in paper form has outlived its usefulness. Credit and debit cards today are increasingly being used for even small transactions. And although today’s crypto-currencies fall far short of being true currencies – for one thing their prices are simply too volatile – the underlying technologies may ultimately strengthen the menu of electronic payments options.2
Zero-interest negotiable bonds as an obstacle to negative policy interest rates
1 An earlier draft of this paper formed the basis for a dinner speech at the April 11, 2014, NBER Macroeconomics Conference in Cambridge MA. The author is grateful to Ruth Judson and Stephanie Lo as well as to NBER conference participants for extremely helpful comments, and to Madhusudan Vijay and Diana Zhu for research assistance.
2 The public may use the terms “currency” and “money” interchangeably, but economists do not. Modern central banks typically report several constructs of money, ranging from a narrow one that includes only currency and (electronic) bank reserves at the central bank, to increasingly broad ones that include, for example, transactions deposits at financial institutions (e.g., checking accounts), time deposits, and holdings of shares at money market mutual funds. Currency in the US accounts for roughly 10% of the Federal Reserve’s main monetary aggregate, M2. 1
Paper currency has two very distinct properties that should draw our attention. First, it is precisely the existence of paper currency that makes it difficult for central banks to take policy interest rates much below zero, a limitation that seems to have become increasingly relevant during this century. As Blanchard et al. (2010) point out, today’s environment of low and stable inflation rates has drastically pushed down the general level of interest rates. The low overall level, combined with the zero bound, means that central banks cannot cut interest rates nearly as much as they might like in response to large deflationary shocks.
If all central bank liabilities were electronic, paying a negative interest on reserves (basically charging a fee) would be trivial. But as long as central banks stand ready to convert electronic deposits to zero-interest paper currency in unlimited amounts, it suddenly becomes very hard to push interest rates below levels of, say, -0.25 to -0.50 percent, certainly not on a sustained basis. Hoarding cash may be inconvenient and risky, but if rates become too negative, it becomes worth it.3
In a series of insightful papers, Willem Buiter (2009 and citations therein) has discussed whether it might be possible to find devices for paying negative interest rates on currency.4 Buiter notes that there were experiments with stamp taxes during the Great Depression (currency would remain valid only if it were regularly stamped to reflect tax payment). There are a variety of other ideas. For example, Mankiw (2009) points out that the central bank could effectively tax currency by holding lotteries based on serial numbers, and making the “winners” worthless.
3 Of course, central banks can and do impose required reserves at sub-market interest rates as a tax on banks. The problem is when the implied interest rates for depositors turn negative.
4 Buiter (2009) credits Gesell (1916) as the first to moot the idea of taxing currency. 2
Paying a negative interest rate on currency, or on electronic reserves at the central bank, may seem barbaric to some. But it is arguably no more barbaric than inflation, which similarly reduces the real purchasing power of currency. The idea of raising target inflation to reduce the likelihood of hitting the zero bound is indeed an alternative approach. Blanchard et al. point out that if central banks permanently raised their target inflation rates from 2% to 4%, it would leave them scope to make deeper cuts to real interest rates in severe downturns. Arguably, paying negative interest rates is a better approach if, as many believe, inflation becomes more unstable as the general level of inflation rises. Robert Hall (1983) argues forcefully that the central role of monetary policy should be to provide a stable unit of account, and in principle the ability to pay negative interest rates facilitates its ability to achieve this in today’s low inflation environment (Hall, 2002, 2012).
Even if there is a good case for allowing the central bank to pay a significant negative interest rate to fight a large deflationary shock, what is to stop a government from using negative interest rates as a wealth tax in normal times? This is a complex issue that parallels many of the problems in trying to design central bank institutions that will resist the temptation to inflate. Nevertheless, the challenges of conducting monetary policy at the zero bound force consideration of alternatives to the status quo. If, as Reinhart and Rogoff (2014) conjecture, business and financial cycles in the 21st century may produce larger fluctuations than they did in the last part of the 20th century, the issue of hitting the zero bound may indeed remain a recurrent one.
Anonymous money as a vehicle for facilitating tax evasion and illegal activity
We now turn to a second drawback to paper currency. Paper currency facilitates making transactions anonymous, helping conceal activities from the government in a way that might help agents avoid laws, regulations and taxes. This is a big difference from most forms of electronic money that, in principle, can be traced by the government. (We discuss the issue of substitute anonymous transactions vehicles such as Bitcoin, later on.)
Standard monetary theory (e.g., Kiyotaki and Wright 1989) suggests that an essential property of money is that neither buyer nor seller requires knowledge of its history, giving it a certain form of anonymity. (A slight caveat is that the identity of the buyer might be correlated with the probability of the currency being counterfeit, but until now this is a problem that governments have been able to contain.) There is nothing, however, in standard theories of money that requires transactions to be anonymous from tax- or law-enforcement authorities. And yet there is a significant body of evidence that a large percentage of currency in most countries, generally well over 50%, is used precisely to hide transactions. I have summarized the international evidence in earlier research (Rogoff 1998, 2002). Other than the introduction of the euro, rather little has changed except that, if anything, anonymous currencies have continued to grow at a faster rate than nominal GDP.
Given that banks and businesses are typically quite efficient in their cash management (as evidenced by several central bank surveys), the most surprising fact about currency is the sheer extant amount that most OECD countries have in circulation, far in excess of anything that can be traced to legal use in the domestic economy. Table 1 gives data on currency by denomination and as a share of GDP for the United States, the Eurozone, Japan and Hong Kong. For example, as of March 2013, there was almost 1.3
trillion dollars in US currency in circulation, or roughly $4,000 for every man, woman and child living in the United States. Moreover, nearly 78% of the total value is in $100 bills, meaning more than thirty $100 bills per person. By contrast, denominations of $10 and under accounted for less than 4% of the total value of currency in use.
The size of dollar currency holdings, relative to GDP or per capita, is hardly unique. Indeed, in the US the currency supply is 7% of GDP, in the Eurozone 10%, and in Japan 18%. Despite having lower per capita income, the Eurozone also has roughly $4,000 in euros for every one of its citizen (valued at the April 2014 euro–dollar exchange rate). The euro has a much greater range of high denominations, so the value is not as concentrated in a single denomination as in the United States. Nevertheless, the same basic phenomenon holds, with roughly a third of the value of euro currency held in 50 euro notes (roughly $70), and another third in 500 euro notes (roughly $700). Adding in 100 and 200 euro notes brings the percent of high-denomination notes close to that of the US. In Japan, the total amount of currency outstanding is similar to that in the United States and Europe, despite having a population size only 40% as large. The concentration in the highest denomination is even more acute, with 87% of the value of notes being in 10,000 yen notes, the largest denomination, roughly $100 at April 2014 exchange rates.5
It is true that in the case of the US and the euro area, there is fairly convincing evidence that a large share is held abroad. Porter and Judson (1996) use seasonal comparisons with Canada and biometric techniques to infer that roughly 70% of US currency is held abroad. It should be noted that Canada is a country that has relatively low currency use compared to many other advanced countries. However, the fact that
5 Rogoff (1998, 2002) looks at a wide range of OECD countries, and indeed the US does not particularly stand out as having high per capita GDP currency holdings. 5
currency outstanding is comparable to the US in so many other OECD countries, most of whose currencies are used only domestically, suggests that perhaps the size of currency holdings in the US is similarly quite large; Rogoff (1998) speculates that the ratio of US currency held internationally may be closer to 50%. Of course, as interest rates have fallen to near zero in recent years, it is not surprising that the demand for currency in the domestic US economy appears to have risen; using similar techniques to her earlier work, Judson (2012) estimates around 50% of US dollars are held domestically post financial crisis. Even if foreign holdings of currency are important for a few countries (including also Hong Kong and Switzerland), this is not thought to be the case for most OECD countries. The Japanese yen does not appear to be a significant international currency.
In any event, it is clear that the long-term trend domestic demand for currency in the legal economy is dwindling, due in part to advances in cashless payments.6 As already noted, the small number of central bank surveys that have been performed to measure domestic use of currency in the legal economy typically find very low percentages, on the order of 10–15% of total extant currency in the case of the United States (see also Feige 2012a, b). Cash is used more intensively in some Eurozone countries. Fischer, Kőhler and Seitz (2004) use a wide range of methods to estimate the transactions demand for currency within the euro area to be 25–35% of total euro currency in circulation. This estimate is broadly in accord with European Central Bank surveys taken after the financial crisis (ECB 2011) that reported holdings and demand for euro in the legal domestic economy of roughly 1/3 of total euros outstanding. Of the remainder, Bartzsch, Rősl and Seitz (2011) look at euro notes issued by the Bundesbank
6 Wang and Wolman (2014) use transaction-level data from a large discount chain to conclude that the cash share of retail sales in the United States will decline by 2.54% per year. 6
and find that between 40 and 55% are held outside of Eurozone countries. (It is quite possible that the overall level of euro notes held outside the Eurozone is lower, since Bundesbank-issued notes are particularly popular, even if in principle all the Eurozone central bank notes should be perfect substitutes.)
Presumably, currency that is not held in the domestic legal economy or in the global economy (legal and underground) is mainly held in the domestic underground economy.7 The underground economy includes agents evading taxes, laws and regulation. The size of the underground economy is not known within any precision, though estimates for the US are on the order of 7–10% of GDP (e.g., IRS 2012, Feige 2012). The IRS estimates that for the benchmark year 2006, the tax gap (tax not paid voluntarily) is over $450 billion, with a gap of $385 billion still remaining after tax collection efforts. Importantly, this estimate does not include the informal economy (US Treasury Inspector General 2013). In Europe, where taxes are higher and regulation is often more onerous, most estimates suggest that the size of the underground economy is considerably larger than in the US (see Schneider, Buehn and Montenegro 2010).
Summing up, currency should be becoming technologically obsolete. However, in no small part due to its association with the underground economy, it is not.
Arguments against phasing out paper currency
The arguments for eliminating paper currency are impressive, but there are important points on the other side of the equation. The most straightforward is seigniorage. The United States money supply increased by an average of roughly $30
7 It is possible that survey respondents underreport even those cash holdings that are for completely legitimate purposes, for example by individuals who simply do not trust banks. I am implicitly assuming this is the not nearly as important quantitatively as cash holdings used to avoid taxes or to engage in illegal activities. 7
billion per year from 2002–2007, and averaged roughly $70 billion dollars per year in the years immediately following the financial crisis. The magnitudes are similar in many other large advanced countries. If a phase-out of paper currency were simply met by an increased demand for electronic central bank reserves, there would of course be no significant loss. However, precisely because paper currency is anonymous, replacing it with non-anonymous electronic money would likely lead to a large shrinkage in demand, and Treasuries would have to absorb the loss. Rogoff (1998) conjectures that this cost might be fully compensated if a modest fraction of the underground economy is induced to pay taxes, and there are also of course potential gains from reduced law-enforcement costs. It is unclear how easily these activities could substitute into other transactions media, but presumably this could be made difficult by restricting other potential anonymous transactions vehicles.
Of course, if the government simply replaced paper currency with electronic currency that it could somehow credibly make anonymous, there would be not necessarily any long-run shrinkage in demand. The government would continue to garner seigniorage revenues from the underground economy and the problem of the zero bound on nominal interest rates would be effectively eliminated. That said, it is far from clear that the government can credibly issue a fully anonymous electronic currency and even if it could, anonymous electronic fiat money has all the drawbacks of an anonymous paper currency in facilitating tax evasion and illegal activity.
There is also a question of how forcing a more rapid shift to cashless payments would affect transactions costs. Retailers are typically forced to pay a pro-rata fee to companies such as MasterCard and Visa for credit card services. But handling paper 8
currency also entails substantial costs to protect against theft and pilferage. Also, in principle, the Federal government could allow individuals to maintain ATMs and debit cards at the Federal Reserve, and arguably these could be serviced by private subcontractors at lower cost than conventional bank services.
Another important argument for maintaining the status quo is that eliminating a core symbol of the monetary regime could disrupt common social conventions for using money, possibly in unexpected ways. For example, it could lead to a precipitous decline in demand for debt and not just for fiat money. This need not happen. In his hugely influential book on monetary policy, Woodford (2003) shows that central bank stabilization policy can work perfectly well in the limit as money’s role in transactions goes to zero. As long as social price-setting convention remains, and as long as the central bank can manipulate banks’ reserves to set the price level, monetary stabilization policy can still operate with full force. However, one must be careful that just because a similar equilibrium can obtain with or without a significant transactions role for money, it does not necessarily mean that private agents will focus on the same equilibrium as they would when there exists paper currency. Yes, the government can help coordinate expectations by insisting that taxes are paid in the electronic fiat currency, and that all state contracts be denominated in this currency. But it is important to acknowledge that there is a least an outside risk that if the government is too abrupt is abandoning a century-old social convention, it will destabilize inflation expectations, introduce a risk premium into bond pricing, and generally induce unexpected macroeconomic instabilities.
There is also a potential risk to central bank independence. Even if eliminating currency is at least revenue neutral for the government as a whole, the central bank is the one that will lose seigniorage revenue. The Treasury is the one that will correspondingly gain through higher tax revenues and lower law-enforcement costs. Under longstanding institutional relationships, the ability to self-finance has put central banks in a privileged position. Although governments typically maintain oversight of central bank budgets, the fact that the central bank nominally appears to be a “profit center” considerably strengthens its hand in maintaining operational independence. In recent years, quantitative easing has been a massive money maker, but this is not the normal state of affairs when currency provision is a key source of revenue.
Another argument for maintaining paper currency is that it pays to have a diversity of technologies and not to become overly dependent on an electronic grid that may one day turn out to be very vulnerable. Paper currency diversifies the transactions system and hardens it against cyber attack, EMP blasts, etc. This argument, however, seems increasingly less relevant because economies are so totally exposed to these problems anyway. With paper currency being so marginalized already in the legal economy in many countries, it is hard to see how it could be brought back quickly, particularly if ATM machines were compromised at the same time as other electronic systems.8
A different type of argument against eliminating currency relates to civil liberties. In a world where society’s mores and customs evolve, it is important to tolerate experimentation at the fringes. This is potentially a very important argument, though the
8 It is true that nearly all disaster-preparedness instructions recommend holding cash, though unless individuals are following this advice, there would still need to be a mechanism for distributing currency after a catastrophe. 10
problem might be mitigated if controls are placed on the government’s use of information (as is done say with tax information), and the problem might also be ameliorated if small bills continue to circulate.9
Last but not least, if any country attempts to unilaterally reduce the use of its currency, there is a risk that another country’s currency would be used within domestic borders. Even if that risk is not great for a country like the United States, there is still the loss of revenue from foreign users of currency (many of whom may be engaged in underground or illegal activities within their own borders, even if not within US borders).10 Thus, any attempt to eliminate large-denomination currency would ideally be taken up in a treaty that included at the very least the major global currencies.
Paper currency came into prominent worldwide use at the time of World War I, and has played a major role in shaping the global history of the last 100 years. Despite huge and ongoing technological advances in electronic transactions technologies, it has remained surprisingly durable, even if its major uses seem to be buried in the world underground and illegal economy. With many central banks now near or at the zero interest rate bound, there are increasingly strong arguments for exploring how it might be phased out of use. True, there are many arguments for not disturbing the status quo,
9 I am implicitly assuming that if only small bills remain in circulation, the central bank would still have the practical capacity to lower interest rates to significantly more negative levels than if large bills continue to circulate, since hoarding costs are much greater for any large sum.
10 Obviously, some foreign use of dollar and euro currency is beneficial to the local economies, even if a significant share goes to facilitating illegal and underground activities. Thus, some countries may consider it detrimental to their interests to see phasing out of dollar and euro paper currency. However, in an era where inflation rates in most countries have fallen radically over the past two decades (making local currencies more attractive), the benefits of being able to use dollar and euro paper currency in the legal economy has presumably been falling, and will continue to do so. 11
ranging from the importance of seigniorage revenues to civil liberties arguments. Given relentless technological advance, embodied in everything from mobile banking to crytocurrencies, we may already live in the twilight of the paper currency era anyway, Nevertheless, given the role of paper currency (especially large-denomination notes) in facilitating tax evasion and illegal activity, and given the persistent and perhaps recurring problem of the zero bound on nominal interest rates, it is appropriate to consider the costs and benefits to a more proactive strategy for phasing out the use of paper currency.
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Sources: http://www.ecb.europa.eu/stats/euro/circulation/html/index.en.html and http://sdw.ecb.europa.eu/browseSelection.do?DATASET=0&sfl1=3&sfl2=4&REF_AREA=308&sfl3=4&BKN_ITEM=NC10&node=5274891
Source: http://www.hkma.gov.hk/media/eng/publication-and-research/annual-report/2012/11_Monetary_Stability.pdf (page 50)
DenominationValue (in thousands of euros)Value (% of total currency)Value (% of 2013 GDP)€ 5€ 8,028,790.80.838%0.084%€ 10€ 20,115,075.42.100%0.210%€ 20€ 57,254,121.05.978%0.598%€ 50€ 335,791,854.335.063%3.507%€ 100€ 183,322,233.019.142%1.915%€ 200€ 39,428,190.44.117%0.412%€ 500€ 289,720,996.030.252%3.026%Total (banknotes)€ 933,661,260.897.491%9.752%All coins€ 24,029,083.22.509%0.251%Total (incl. coins)€ 957,690,344.0100%10.003%EUROPECurrency in circulation – February 20, 2014DenominationValue (in billions of HKD)Value (% of total currency)Value (% of 2012 GDP)HK$10HK$2.920.967%0.143%HK$20HK$11.383.773%0.558%HK$50HK$7.002.322%0.344%HK$100HK$27.138.998%1.332%HK$500HK$74.0924.574%3.637%HK$1,000HK$169.1956.115%8.305%Total (banknotes)HK$291.7096.750%14.319%All coinsHK$9.803.250%0.481%Total (incl. coins)HK$301.50100%14.800%HONG KONGCurrency in circulation – end 2012
Table 1 continued
DenominationValue (in 100 millions of yen)Value (% of total currency)Value (% of 2013 GDP)¥500¥1,0660.118%0.022%¥1,000¥38,0364.193%0.795%¥2,000¥1,9950.220%0.042%¥5,000¥29,5953.262%0.619%¥10,000¥790,19687.101%16.519%Total (banknotes)¥861,33594.942%18.006%All coins¥45,8845.058%0.959%Total (incl. coins)¥907,220100%18.965%JAPAN Currency in circulation – February 2014DenominationValue (in billions of dollars)Value (% of total currency)Value (% of 2013 GDP)$1$10.60.885%0.063%$2$2.10.175%0.013%$5$12.71.060%0.076%$10$18.51.544%0.110%$20$155.012.935%0.923%$50$74.56.217%0.443%$100$924.777.168%5.504%$500 to $10,000$0.30.025%0.002%Total$1,198.3100%7.133%Currency in circulation – December 31, 2013UNITED STATES