A Case for the Abolition of Cash

While the abolition of cash is not likely to happen in the foreseeable future, at least in the UK, the idea has been given some attention lately. Andy Haldane, the Chief Economist at the Bank of England, and Ken Rogoff, Professor of Public Policy at Harvard, have both come out in favour. They cite two main reasons; reducing the ease with which the shadow economy can function and ending the ‘zero lower bound’ for the base rate.

Before examining it is worth looking at the current state of ‘cash’ in the UK and abroad. There are two primary uses for cash; a medium for exchange and a store of value, and it is used in three locations, domestically, abroad, and in the shadow economy. There is currently around 40% of UK GDP (£62bn) in printed notes, up from a low of 30% in the early 90s. But where is this cash?

Of the £1000 for each person in the UK, £210-£270 is in the domestic transactional cycle, around £80 is hoarded – the rest is hard to track precisely. With the UK’s shadow economy amounting to only 10% of GDP (one of the lowest in the OECD) and crime falling every year for the last decade it is not expected that very much of this is in the shadow economy.

Perhaps the less important argument for the abolition of cash is to make illegal economic activity more difficult. Payments by cash are untraceable, so any activity that one would not wish the government be aware of, is better done using cash. This activity ranges from drug deals to cross-border weapon trade. There would also be a clamp down on small-scale tax evasion, such as self-employed workers being paid in cash. Given the small size of this underground economy, and the fact that self-employed incomes are typically lower, removing cash would likely bring in less than 1% of GDP of tax revenue – not significant but certainly not negligible. Alongside this there is the possible advantage of people being less able to perform potentially dangerous transactions, but again, the magnitude of this benefit is unknown.

The primary reason for the abolition of cash given by both Haldane and Rogoff is that it would remove the zero lower bound on the Bank of England’s base rate.

The Bank of England’s primary macroeconomic function is the setting of interest rates – the reward (or cost) of depositing money in banks. When the economy is stagnating and inflation is low, the BofE will lower the reward for saving (interest rates), encouraging people to spend or invest their money. This lowering will work until interest rates are zero, at which point, in theory, people will simply withdraw their deposits and keep them as cash rather than ‘paying’ to store their money in a bank. The abolition of cash prevents this escape option, allowing central bankers to charge negative interest rates.

Have we ever needed negative interest rates? Will we need them in the future? The Bank of England, Bank of Japan, Federal Reserve and European Central Bank have had rates below 1% since 2009 – all four economies have been struggling below their 2% inflation target. While it is debated whether or not this is temporary, there is evidence to suggest the natural rate (central bank base rates at which savings are equal to investment demand) is becoming negative (Mervyn King 2013) (Krugman 2014). Possible reasons for this include; a slowing growth in the working age population, a shift away from reliance on debt fuelled growth (as experienced from 2000-2007), and a reduction in potential growth (about 1%). The ability for central banks to set negative rates will allow more effective treatment of the stagnation currently experienced.

The abolition of cash is a controversial move – physical money has been a key part of most economic systems since antiquity, but, perhaps, if western developed economies continue to suffer from their current stagnation, the need for negative interest rates will become so great as to force it.

Contributed by Michael Tallent, Editor in Chief.

 

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