Modelling currency demand: the case of the euro
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Modelling currency demand: the case of the euro António Rua1,2 Received: 4 November 2019 / Accepted: 4 September 2020 © Springer-Verlag GmbH Germany, part of Springer Nature 2020
Abstract Liquidity management is a key mission of a central bank. In particular, the adequate provision of banknotes requires the understanding of what drives currency demand. The challenge is even bigger in the case of the European monetary union where the euro continues to develop into a well-established currency outside borders. In this respect, a novel indicator is proposed to reflect foreign demand developments. Moreover, besides the usual set of determinants, variables covering financial and economic policy uncertainty are also taken into account. The full denominational breakdown of banknotes is considered so as to unveil the heterogeneous role played by the several drivers. It is found that external demand is relevant for large denominations and uncertainty also matters for cash demand. Furthermore, the recent ECB announcement of the end of issuance of the largest denomination banknote led to a reduction in the overall demand for euro banknotes. Keywords Banknotes demand · Euro · Denominational breakdown · DSUR · SUR ECM JEL Classification C32 · E41 · E50
1 Introduction Notwithstanding the evolving payment systems, cash still remains an essential part of everyday use [see, for example, Bagnall et al. (2016) and Esselink and Hernandez (2017)]. In this respect, countries belonging to the euro area faced a major change at the time of the introduction of the euro with the undertaking to exchange the legacy currency notes and coins for their euro-denominated equivalents. In particular, the physical introduction of the euro on the 1 January 2002 meant the largest-ever currency changeover affecting more than 300 million people. The impact of the changeover to
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António Rua [email protected]
1
Banco de Portugal, Lisboa, Portugal
2
Nova School of Business and Economics, Carcavelos, Portugal
123
A. Rua
euro currency was also felt outside the euro area as legacy currencies, namely the Deutsche Mark, were already being used throughout the world. Banknotes in circulation appear under the autonomous factors on the Eurosystem balance sheet, as the central bank meets any demand. Being one of the largest autonomous factors, it becomes crucial to understand the drivers of banknotes demand for the ECB liquidity management. Although the central bank knows exactly the outstanding amount of banknotes in circulation, there is no way to know who holds it, why and where it circulates. Besides the usual motives for holding currency, such as for transactions purposes or as store of value, in the case of the euro, it is even more challenging to model demand due to its international role [see, for example, Bartzsch et al. (2013a, b)]. According to the ECB (2018), it is estimated that around 30% of the currency in circulation was held outside the euro area at the end of 2017. Other major currencies, such as the US dollar, are also known to ha
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