Written communication

Prepared by Alejandro Zamora-Pérez

1 Introduction

• Recent payment surveys indicate that the share of cash transactions in the euro area has decreased.
• In fact, the number of euro banknotes in circulation has increased since 2007 (see Chart 1).
• This seemingly counterintuitive paradox can be explained by demand for banknotes as a store of value in the euro area (e.g.
• euro area citizens holding cash savings) coupled with demand for euro banknotes outside the euro area.

Chart 1

(left-hand scale: value, EUR billions, non-seasonally and non-calendar adjusted; right-hand scale: percentages)
• [3] This growth in circulation has intensified during the coronavirus (COVID-19) pandemic.
• At the end of 2020, the value of euro banknotes in circulation amounted to 1,435 billion, increasing by 11% from 1,293 billion in 2019 (Chart 1).
• The only time the growth rate was higher was during the months following the Lehman Brothers collapse in September 2008.
• [4] However, the growth of euro banknote circulation has been remarkably strong since they were introduced even when compared to some other macroeconomic magnitudes; for example, the ratios of euro banknotes to nominal gross domestic product (NGDP) and to M3 have increased over the years (see Chart 2), amounting to 10.83% and 9.94% at the end of 2019, respectively.

Chart 2

Euro banknotes over euro area nominal gross domestic product and M3 (percentages, year-end figures)
• Central bank cash and liquidity management activities can be improved by a good understanding of the demand for cash.
• In addition, the size and growth of some components of cash demand have relevant implications when assessing the monetary policy stance and its implementation in a low interest rate environment.
• Estimating the size of these components is key to understanding the paradox of banknotes.
• There are also grey areas where it is impossible to define when a banknote is held for transactions or as a store of value.
• Nevertheless, it is possible to learn about the different uses of banknotes through direct (i.e.
• Section 4 will address the COVID-19 developments during 2020, remarking on the importance of cash during crises.

2 Transactional use of cash in the euro area

• Estimates of the value of banknotes held for transactions in the euro area can be produced using indirect approaches but these are subject to limitations.
• Indirect approaches use available ECB data on euro cash coupled with a set of assumptions to produce estimates of the portion of the value of banknote circulation used for domestic transactions.
• However, the reliability of these methods depends on the particular assumptions employed, and therefore they should be considered with an appropriate level of caution.
• The share of banknote circulation used for euro area transactions can be estimated using the seasonal method.
• Results indicate that, in 2019, between 13% and 30% of the value of euro banknote circulation was used for transactions in the euro area (see Chart 3).
• It is also worth noting that both benchmarks indicate that the share of circulation used for domestic transactions has decreased over the years.

Chart 3

Estimates of the share of value of euro banknotes held for domestic transactions according to the seasonal method (percentage of total circulation)
• Different denominations of euro banknotes return to Eurosystem central banks at varying frequencies.
• [10] Banknotes returning less often are partly circulating in domestic channels more distant from central banks and partly stored domestically or held abroad.
• An analysis of the introduction of the second series of euro banknotes provides further information on how the different denominations of banknotes circulate.
• The introduction of the second series of euro banknotes and the subsequent replacement of the first series provides valuable information.
• [11] Chart 4 illustrates this for 5 (typically transactional, like the 10 and 20 denominations) and 50 denominations (used for transactions but also as a store of value domestically and abroad like other high value denominations 100 and 200).
• For low (typically transactional) denominations one would expect that most banknotes return to the central bank.

Chart 4

Analysis of the €5 and €50 banknote saturation rates (percentages, monthly data)
• Although indirect methods can provide valuable estimates of the use of cash for transactions domestically, direct methods such as payment surveys are necessary to supplement our indirect knowledge.
• However, the share of cash payments has decreased in the past three years by six percentage points.
• According to the survey, euro cash has been used for 117 billion physical and online transactions, corresponding to a value of 1,993 billion.

Box 1 Domestic transactional use of cash, evidence from the SPACE survey

• [16] The significant difference between number of transactions and value is due to the more frequent use of cash for low-value transactions.
• For both POS and P2P combined, payments below 15 represent most of the transactions made as shown in Chart A (left-hand panel).
• 92% of payments below 5 are made in cash while only 33% of transactions above 100 (which represent only 3% of all POS and P2P transactions) are paid in cash (see Chart B, right-hand panel).

Chart A

Use of payment instrument at POS and P2P, by value range (x-axis: percentage, share in all transactions; y-axis: value, transactions)
• Other person-to-business payments where cash is used are the recurring payments such as to pay electricity bills, telephone bills or rent, with large differences across countries and types of service.
• Around 6% of citizens in the euro area pay electricity bills in cash, with a high variability across countries (ranging from 1% to 38%).
• The use of cash is lower for rent (4%) and phone bills (5%), also with significant differences in euro area countries.

3 The non-transactional demand of banknotes

The central estimates of the previous section suggest that around 80% of the value of banknotes in circulation was not actively used for domestic transactions in 2019, and this share has risen over the years. The following section will present the available evidence on the remaining components of cash demand, namely foreign demand and domestic store of value.

The circulation of euro banknotes outside the euro area

• net) euro banknotes shipped in and out of the euro area via banking channels only represented 13% of total banknote circulation in terms of value.
• However, the study clarifies that there are several channels through which banknotes can flow in and out of the euro area, such as non-registered remittances or tourism.
• According to a method developed by the ECB, in 2019 around 30% of the total value of banknotes in circulation was held abroad.
• These two methods compare certain characteristics (such as seasonality or the lifespan of banknotes) of the euro banknote population with other, otherwise similar, reference countries banknote populations.
• The wide interval resulting from the different methods reflects the complexity of estimating the size of the foreign demand component of euro banknotes.
• A macroeconometric model of euro banknote demand and quantitative and qualitative analyses of the determinants of euro net shipments find that mostly local factors (from countries demanding banknotes) influence foreign demand.

The use of euro banknotes for domestic store of value

• Between 27.5% and 50% of the value of banknote circulation is thought to be stored in the euro area in 2019, meaning that per-adult cash reserves (of euro area citizens as well as of banks and companies) range between 1,270 and 2,310.
• Using the estimates that around 20% of the value in circulation was used for domestic transactions and between 30% and 50% was held abroad, this means that in 2019 between 27.5% and 50% was used for store-of-value purposes in the euro area.
• [24] This implies that the amount of cash reserves per-adult ranged between 1,270 and 2,310.
• It should be stressed that this per-adult amount includes peoples holdings, but also cash held by euro area monetary financial institutions (MFIs) and companies.
• Despite its pronounced increase, vault cash only represented around 7% of total banknote circulation at the end of 2019 so it can by no means entirely explain the increase of domestic store of value usage.

Chart 5

Vault cash held by MFIs and Deposit Facility Rate (left-hand scale: value, EUR billion; right-hand scale: percentage points, end-of-month figures)
• However, it is likely that, as is the case with other currencies that experienced a high increase in non-transactional demand, the low interest environment cannot fully explain the rise in demand.
• It is possible that other factors, such as increased uncertainty or the ageing of the population, may be at play.
• This means that survey results must also be considered with an appropriate level of caution.
• Box 2 presents evidence from SPACE on cash reserves, as well as from a recent nationwide survey in Germany studying the motives of why German citizens save in cash.

Box 2 Domestic cash holdings of euro area citizens: evidence from two recent surveys

Prepared by Chiara Litardi and Alejandro Zamora-Pérez

Descriptive analysis of SPACE data on cash reserves by euro area citizens

• SPACE data show that around one out of three respondents kept cash reserves at home in 2019, with sizeable differences across countries.
• 34% of respondents declare to hold cash reserves, while 62% declared that they dont hold any cash and 4% refused to answer.
• In some countries, up to 50% of respondents report keeping extra cash.
• Some of the respondents who reported keeping cash at home refused to disclose how much cash they store (7%).
• In the euro area, there are important differences across socio-demographic groups such as gender, education and income (see Chart A).

Chart A

Amount of cash reserves (€500 and above) by demographics (Percentage of the overall population)

Results from a German study

• To obtain this data, the survey employed a number of confidence-boosting measures to reduce the bias of underreporting the amounts of cash reserves and gain insight into other sensitive aspects.
• Regression results point that age, income and employment status have an influence on holding cash reserves.
• Older people tend to hold more cash outside their wallets, although the increase of holdings by age is not linear (cash reserves seem to be accumulated until shortly before retirement).
• The average cash amount that individuals save rises with income, and the bulk of the value of cash holdings seems to be concentrated among the top percentiles of the income distribution.

4 The increase in banknote issuance during crises: the case of the COVID-19 pandemic

• During 2020 the increase in banknote circulation was abnormally high due to the COVID-19 pandemic, a trend that has also been observed in other crises periods.
• During different types of crises, people tend to increasingly demand cash, and the COVID-19 crisis was no exception (see Box 3).
• Chart 6 shows the net issuance of euro banknotes in 2020 and compares it with the previous two (normal) years.

Chart 6

Cumulated net issuance of euro banknotes in 2020 compared with previous years (EUR billion, cumulated net issuance, end-month figures)

Box 3 Cash and crises

• Prepared by Gerhard Rsl and Franz Seitz It has been observed globally that, in the past, an important driver of high increases in cash holdings has been rising cash demand due to crises.
• [28] As can be seen in Chart A, cash demand has increased in major currency areas during all the included crises, sometimes quite drastically.

Chart AAnnual growth rates of cash in selected countries

(local currency)
• The surge in cash in circulation (see Chart A) around the millennium was thus driven by transaction and precautionary motives as well as the desire to store value.
• [29] Domestic demand for cash around Y2K was often also fuelled by an increase in banks vault cash, especially in the United States.
• In the United States, where the financial crisis originated, but also in the euro area, in Switzerland and in the United Kingdom, cash issuance went up considerably.
• In Japan, in contrast, which was not as heavily hit by the crisis, neither overall cash issuance nor single yen denominations showed an unusual increase.
• In the United States as well as in the euro area, annual growth rates of small banknote transaction balances exceeded those of the largest denominations in mid-2020, whereas the opposite was true for banknote issuances in Switzerland and Japan.
• The survey to measure the impact of the pandemic on cash trend (IMPACT survey) provides an indication as to changes in payment behaviour during the first stages of the COVID-19 pandemic[30].
• Although around half of the respondents reported using cash and cards in a similar manner as they had before the crisis, around 40% declared that they were using contactless payment cards more often.
• The same share (40%) of respondents declare that they were using cash much less often or somewhat less often.
• This would point towards a further decrease in transactional demand for cash, although researchers have observed that consumer perceptions or self-reported preferences are normally not indicative of payment behaviour.
• [31] Hence, further survey evidence after the pandemic is needed to assess whether these findings will be consolidated after the pandemic.
• Reasons for this behaviour could include increased uncertainty and reduced mobility (leading households to hold higher amounts, thereby reducing the need to go to a cash dispenser).

5 Conclusions

• Although cash is still the most used means of payment at POS and P2P according to recent ECB surveys, the share of cash transactions versus other payment methods has decreased over time.
• However, cash demand has increased overall, and decomposing banknote circulation into its three components (euro area transactional demand, store of value inside the euro area and foreign demand) is key to explaining this increase.
• The wide intervals of the estimates indicate a high uncertainty due to the fact that the ways people actually use cash is not directly observable.
• Figure 1 depicts the estimated size of the different components of banknote demand.

Figure 1

Estimates of components of euro banknote circulation (percentages, rounded figures without decimals)