Erkki Liikanen: Cash and the central bank
Opening remarks by Mr Erkki Liikanen, Governor of the Bank of Finland, at the Bank of Finland
Conference on Going Cashless, Helsinki, 14 June 2016.
* * *
Dear friends and colleagues,
I want to welcome you all to this conference organized around a very old and at the same time
a most timely topic: cash.
Central banks have always thought a lot about cash, of course. But until recently, it was mainly
seen as a logistical and security matter. This is changing.
Now, we have to consider the role and the future of cash from more fundamental perspectives.
***
One perspective is the effect of information technology. Technological change has always
shaped banking. Historically we see the impact of such inventions as the telegraph, the credit
card, the ATM, and electronic fund transfers. But how about notes and coin?
In essence, cash is a way to store and convey information: information about the purchasing
power of the bearer. But cash is not the only possible way to do it. Information technology
offers more and more alternatives, many of which compete in today's marketplace.
Technological development has made it possible to offer improved services and to increase
efficiency in the payments industry. But the technological imperative is not the only force at
play. Commercial incentives are also important. The utilization of the technological possibilities
has sometimes been spurred by crises.
Finland is an example of this.
After the Nordic banking crisis in the early 1990s, our banking sector had to go through major
cost-cutting and productivity improvements. During the 1970s and 1980s the banks had
invested very much in the ICT, which was made possible due to high profitability. In this
structural change, Finnish banks profited from these investments in changing their way to
operate and they became forerunners in internet-banking. This shows once more how
necessity becomes the mother of invention.
Today, Finland and the other Nordic countries are pretty advanced in the electrification of
payments, and most people can go about their daily lives perfectly well without touching cash.
And many do so. Contactless payment cards are among the new developments which, by their
convenience, pose a serious challenge to cash in terms of sheer technical efficiency and
timesaving.
By the way, Finland was a pioneer in the use of contactless smart cards for payments. They
were first introduced by the mid -1990's in the public transit systems of several Finnish cities
like Oulu and Tampere.
Technology is not only about efficiency. Other features of cash are also challenged. Some are
quick to claim that new cryptocurrencies such as Bitcoin can now offer users the same
anonymity which has long been thought to be the unique quality of cash.
It has even been said, that cash, that is, notes and coin, is "on trial", to cite the title of a recent
conference.1 The question we must be prepared to answer is: what is the justification for cash
as a means of payment on the face of such developments.
Answering that question could shed important light on some fundamental questions on the
nature and role of central banking in general. This is one of the reasons this conference has
been arranged.
***
Another reason for the discussion has recently been the low-interest rate environment which
now prevails in much of the developed world. This situation has focused the attention of
economists to the so-called zero lower bound of interest rate policy.
The zero lower bound problem results from the availability of cash as a liquid investment
alternative, with zero return (minus storage and insurance costs). The alternative constituted
by cash makes it difficult, perhaps impossible, to push market rates very far into the negative
territory.
Practice is not quite as simple as theory. Recent experience tells us that interest rates can be
somewhat negative, even if there are no restrictions on banknote holdings. Holding large
amounts of cash is not costless. As a result, the effective lower bound can be soft, and
somewhere below zero.
In the proximity of the lower bound, central banks, ECB included, have supplemented their
toolkit with forward guidance and with various unconventional measures, such as large-scale
asset purchases. These have helped to keep monetary policy effective even in today's
exceptional low-interest environment.
The question relevant for today is, is the lower bound for interest rates a serious problem for
the efficiency of monetary policy? And if it is, is the problem persistent enough so that we
should take radical measures to remove the lower bound?
There are economists, such as Kenneth Rogoff, who think that it would be best to discontinue
cash altogether, in order to liberate monetary policy from the lower bound, letting interest rates
move more freely to both directions. I think this is not the mainstream view now, however.
The seriousness of the lower bound problem in the future depends partly on what happens to
the average level of interest rates. This in turn depends on the return of inflation tendencies in
the economy, and the equilibrium level of the real interest rate in the future.
Here we encounter one of the most interesting topics of economic discussion these days: the
secular stagnation hypothesis. It has got a lot of attention but has not convinced everybody.
The issue is intensely debated by academics.
Many countries were hard hit by the global financial crisis. Recovery has been slow and uneven
although it has been taking place. Productivity growth has been slowing down for many years,
almost globally.
For the future, we can think of two scenarios. In the first, the deceleration of growth would turn
out to be temporary. In that case, the issues raised by the low interest rate environment and
the lower bound problem would eventually become less topical. The equilibrium real interest
rate would return to more customary levels, and any deflationary tendencies would recede.
The average interest rate level would be normalized.
I still inclined to think that scenario to be the likely one.
In the second scenario, we would face a permanent and significant slowdown of productivity
growth. This would imply that the equilibrium interest rates could be very low for a very long
time, perhaps occasionally negative. The central banks would be more likely to hit the lower
bound for interest rates more often.
That would be the case in which removing the lower bound for interest rates would be
something to think about.
This is clearly a complicated matter:
• The experience with alternative monetary policy measures would have to be
assessed: how well can we substitute other monetary policy instruments for interest
rate policy if needed?
• The realism of a world with occasionally negative nominal interest rates would have
to be considered, not only in money markets, but in retail banking too. The customer
resistance to negative nominal rates for their savings could be very stiff. Bank
profitability could be a serious issue.
• Finally, the pros and cons of a payment system without cash would have to be
examined. What would be lost in terms of convenience, resilience and privacy if cash
was discontinued? Should it be replaced with something new?
Before a judgement could be passed regarding the future of cash, all these aspects would
need to be carefully considered and balanced.
***
Currently, the role of banknotes in payments is diminishing, and the role of credit and debit
cards is growing. Curiously, the total value of banknotes in circulation has not decreased in
most countries, and has even been growing. This is an interesting puzzle which may be one
of the results of the very low interest rates prevailing.
Anyway, the infrastructure needed for cash withdrawals has gradually been downsized in some
countries. The international differences are large. The Nordic region is leading the way. The
number of ATMs has been diminishing for years here. Many bank branches do not handle
cash any more. In the emerging situation, at least in Finland and the other Nordic countries,
obtaining cash has probably become more time consuming and difficult for customers who
prefer to use it.
The commercial case, apart from regulation, for maintaining facilities for distributing and
receiving cash may vanish. We may be approaching a tipping point, where cash is not only
losing market share, but may be increasingly disappearing as an option.
For most of the population, for most purposes, and for most of the time, this trend is not very
problematic. But the payment system is a utility which must be accessible to everybody, not
only the majority of people. It must be inclusive. So that raises the issue of how social groups
with special needs can cope without the option of using cash.
Do we need new kinds of regulations on the right-to-access to electronic payments systems,
or new regulations on the distribution and acceptance of cash?
Another interesting hypothetical question is what should be the role of the central bank in a
such an hypothetical economy where physical cash would no longer exist. Should the concept
of legal tender be redefined, and should the retail customers have access to central bank
money in such an economy?
Different ideas have been floated. Some people think that citizens should be given the option
of opening transaction accounts at the central bank. Some have proposed that the central
banks could issue circulating digital currency by using the distributed ledger technology, like
the Bitcoin does. There have been other ideas, too.
***
At present, central banks are not trying to actively direct the payment system away from cash,
nor trying to promote its use. The commercial forces have been given a leading role, while the
central banks have seen to it that legal tender is available when needed. This has worked well
so far. But we must think ahead, and clarify our position on these issues, and interaction with
researchers and experts is invaluable to help us in that.
I should make a side remark here. As we all know, the Eurosystem will discontinue the
production and issuance of € 500 banknotes. The elimination of the largest-denomination
banknote is hoped to have an impact in limiting the underground economy and making all kinds
of illegal transactions more difficult. Its use in ordinary transactions has not been large in any
case.
Some people have been disappointed by this decision, and interpreted it as a sign that the
ECB is taking a more negative view on the future of cash in general. This is a misinterpretation.
The decision should not be overdramatized. For a comparison, in the U.S. the $ 100 bill is the
largest banknote. The ECB is not taking a radical step in discontinuing a € 500 banknote. At
the same time the new series of € 200 and € 100 notes will be introduced to meet the all the
demand. There is no change in our attitude on the future of cash.
***
To conclude, cash has never been more interesting than now. Increasingly, the central banks
and the whole society need analyses which go to the foundations of the monetary and
payments system. I trust this conference will make a valuable contribution to this fascinating
research area.
I thank you for your attention, and wish you a very productive conference day.