A tale of two countries: Cash demand in Canada and Sweden

Superb paper by Walter Engert and Ben S. C. Fung (Bank of Canada) and Björn Segendorf (Riksbank). They try and understand why cash demand is different in the two countries.

First, Sweden and Canada economies are quite similar:

Canada and Sweden are similar in many ways. For instance, both of these northern countries are small, open economies that neighbour on much larger economies (the United States and those in the euro zone, respectively). Each has its own national currency, while citizens have easy access to an international reserve currency (the US dollar and the euro).

The macroeconomic environments in Canada and Sweden also share similarities. For example, both Canada and Sweden have monetary policy frameworks that target inflation, and both have pursued the same inflation-control objective (2 percent) since the beginning of the 1990s. Their banking systems are broadly similar, each dominated by a handful of large, universal banks, but also includingmany smaller institutions. Canada and Sweden also both rank high in terms of digital infrastructure relevant to cashless payments; both are seen as among the most significant adopters of cashless payment methods and both are considered among the most cashless societies in the world.

Finally, each has experienced a range of payment innovations over the past few decades (e.g., Swish in Sweden, and Interac e-Transfer in Canada) that have contributed to the reduced use of cash for payments.

Yet they differ in cash usage:

And yet, despite the similarities, the evolution of overall cash demand is very different in the two countries, as shown above. It follows then that studying the factors driving cash demand in Canada and Sweden could inform our understanding of the importance of various influences and provide some insight into the evolution of cash demand in Canada: Will cash demand in Canada follow Sweden’s path? 

The evidence shows Sweden and Canada are similar in usage of small notes where demand has declined in both. However, when it comes to large notes, there are differences:

We address these questions by focusing separately on small notes used for transactions and larger notes typically used as a means to store value. We find that Canada and Sweden show a similar long-term downward trend in small-denomination bank notes relative to GDP, reflecting declining cash use for transactions in both countries. These outcomes have been driven by the adoption of similar retail payment innovations in the two countries. At the same time, merchant acceptance of cash has been (to this point) nearly universal in Canada and in Sweden. So neither differences in payment innovations nor in merchant acceptance of cash can explain why cash-to-GDP has been declining rapidly in Sweden but not in Canada.  

But differences emerge between the two countries in the demand for larger-denomination bank notes. These seem to be the key to explaining their divergent cash-to-GDP trends. In Sweden, three influences have decreased the demand for larger bank notes over time. First, given the Swedish experience, people there might expect that in financial crises the actions of public authorities will secure bank deposits. This reduces the need for cash as a safe store of value. Second, cashless bank branches in Sweden have created frictions that inhibit access to larger bank notes. And third, Swedish legal tender rules that declare specific old bank note series invalid appear to have discouraged people from holding larger bank notes generally. In Canada, by contrast, there is some evidence that foreign demand for larger Canadian bank notes has increased somewhat in recent years. 

The analysis points to three broad lessons.

    1. Policy interventions and bank resolution frameworks (like “bail-in”) that protect deposits in financial crises reduce incentives to hold larger bank notes as a hedge against heightened risks. This also suggests a reduced need for central bank digital currency as a safe store-of-value in crisis (Engert, Fung and Hendry 2018).
    2. Cashless bank branches can inhibit access to cash, particularly if ATM networks do not satisfy consumer demand across a range of note denominations or provide adequate cash-deposit services, especially for merchants.
    3. Legal tender rules that periodically declare old bank note series invalid can have the unintended consequence of inhibiting the demand for cash more generally, an impact that is stronger the more frequent the declarations and the more difficult the process of exchanging old (invalid) notes for new notes.

Hmm…

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