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A World without Cash – The limits of Monetary Policy

Money was created thousands of years ago and has ever since maintained its three primary functions as a medium of exchange, a standardised unit of value and a means of storage. Over time the format changed from commodity money to fiat money but it always stayed hard cash. Only with the transition into the information age, has electronic cash been introduced and with it the time has come to question whether hard cash is still useful.

Since the economic crash in 2008, economies around the world are trying to get back on their feet. America most of all suffers from a lack of demand and desperately tries Keynesian monetary policy to force an economic upswing. In an attempt to create investment incentives the key interest rates were pushed downward. This has led to the first time in history that the Federal Funds Rate has reached the zero percent mark on the 16th of December 2008. Ever since, the target rate has stayed at the 0-0,25% level which strongly limits the Federal Reserve’s room of manoeuvre.

This phenomenon known as the Zero Lower Bond can be overcome in a world without cash. Macroeconomic models suggest further decrease of the key interest rate beyond 0% but the opportunity costs of storing money at the bank will lead people to store in cash instead. In consequence the key interest rate cannot be pushed beyond zero as it would have no effect but rather lead to a bank-run. Only when cash is removed from this equation will people no longer have the possibility to store money under their mattresses, thereby eliminating the constraint of the Zero Lower Bond.

Now if Central Banks decide to set key interest rates lower than zero, commercial banks can pass those on to their customers, who can no longer avoid the policy. In consequence they will lose purchasing power by the minute, promoting their willingness to spend and thereby propelling the economy. Keynesian monetary policy regains impact.

The level of desperation to regain impact through monetary policy is illustrated through the latest actions of the European Currency Union. On 11th June the ECB, which commonly errs on the side of conservatism, set the deposit facility (effective for overnight deposits) to -0.1%. The goal is to penalise private banks that park money at the ECB. As a reaction Commerzbank, Germany’s second largest bank, announced to preserve its right to introduce a fee on large deposits. Or in other words, to introduce negative interest rates on deposits that are too big to fit under the mattress. Deutsche Bank is also said to consider similar actions.

European Central Bank Policy Rates

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The theoretical possibility of lowering key interest rates below zero in times of crises has been studied by the Federal Reserve of Cleveland. In a recent paper they pretend that unconventional monetary policy instruments such as Quantitative Easing or even forward guidance were not exploited during the heights of the crises (2009/2010). With this assumption they estimate that the efficient interest rate would have been around -5%. Holding such a negative interest rate would strongly encourage customers to shift their consumption pattern towards today rather than saving for tomorrow, finally diminishing economic downward spirals.

Apart from the positive effects on the potential of ECB interventions, a cash-free economy can also benefit the fight against criminality. Shadow economies including the black market can be observed significantly easier. A bank note does not tell where and how an illegal transaction takes place. An electronically registered cash flow, however, can be traced back to seller and buyer, eradicating the seller’s ability to stay unidentified. Forgery is made impossible and in the same breath tax evasion gets increasingly complicated, both due to registered cash flows.

Hence, cash-free economies hold significant advantages. They widen the possibilities of conventional monetary instruments and help to confine criminal activities.

Yet, for the timing being, cash remains to be an important way of performing monetary transactions. Especially nowadays, people are sceptical of being monitored in every step they take. Therefore a preference for being able to buy things without leaving traces, even if purchases are of a legal nature, stands in the way of eliminating cash. If a single currency regime tried to force the change into electronic cash, citizens could simply substitute it with foreign currencies or even digital currencies such as Bitcoin.

Still, the time being is a transition phase. Sweden is a pioneer in this regard, slowly pushing towards a cash-free society, in which even the homeless carry a credit-card reader. In the long-run, hard currency will be replaced by electronic cash and with it new possibilities in multiple areas of economics will open up.

Amery Gülker 761 and Lars Uden 744


Author: studentnovasbe

Master student in Nova Sbe

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