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The evolution of cash transactions : some implications for monetary policy

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  • Stacey L. Schreft
  • Bruce D. Smith

Abstract

This paper considers the implications for monetary policy of a decreasing demand for outside money. It finds that even perpetual declines in the demand for base money pose no threat to the traditional methods employed for conducting monetary policy. The effects of such reductions in the demand for central bank liabilities, however, do depend on how monetary policy is conducted. Four monetary policy regimes are analyzed. With a policy of nominal-interest-rate targeting, a secular decline in the volume of cash transactions unambiguously leads to accelerating inflation. A policy of maintaining a fixed composition of government liabilities leads to accelerating (decelerating) inflation if agents have sufficiently high (low) levels of risk aversion. Inflation targeting produces falling nominal and real interest rates, while a policy of fixing the rate of money growth can easily lead to indeterminacy and endogenous oscillation in interest rates. It is argued that a policy of fixing the composition of government liabilities has several advantages if it is known that agents are not too risk averse and that the asymptotic demand for base money is small. If this information is not known, then interest-rate or inflation targeting have an advantage because their consequences are not sensitive to such environmental features.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number 99-02.

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Date of creation: 1999
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Handle: RePEc:fip:fedkrw:99-02

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Keywords: Payment systems ; Monetary policy - United States ; Cash flow;

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References

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  1. Stephen D. Williamson, 1998. "Discount Window Lending and Deposit Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 246-275, January.
  2. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  3. Stacey L. Schreft & Bruce D. Smith, 1995. "The effects of open market operations in a model of intermediation and growth," Working Papers 562, Federal Reserve Bank of Minneapolis.
  4. Michael Woodford, 1998. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 173-219, January.
  5. Gordon H. Sellon, Jr. & Stuart E. Weiner, 1996. "Monetary policy without reserve requirements: analytical issues," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 5-24.
  6. Greenwood, J. & Smith, B.D., 1995. "Financial Markets in Development, and the Development of Financial Markets," RCER Working Papers 406, University of Rochester - Center for Economic Research (RCER).
  7. Schreft, Stacey L. & Smith, Bruce D., 1997. "Money, Banking, and Capital Formation," Journal of Economic Theory, Elsevier, vol. 73(1), pages 157-182, March.
  8. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  9. Champ, B. & Smith, B.D., 1991. "Currency Elasticity and Banking Panics: theory and Evidence," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9109, University of Western Ontario, The Centre for the Study of International Economic Relations.
  10. Schreft, S L, 1992. "Transaction Costs and the Use of Cash and Credit," Economic Theory, Springer, vol. 2(2), pages 283-96, April.
  11. Ireland, Peter N., 1994. "Economic growth, financial evolution, and the long-run behavior of velocity," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 815-848.
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Cited by:
  1. Sheri M. Markose & Yiing Jia Loke, 2002. "Can cash hold its own? International comparisons: Theory and evidence," Economics Discussion Papers 536, University of Essex, Department of Economics.
  2. Andreas Schabert, 2006. "Central Bank Instruments, Fiscal Policy Regimes, and the Requirements for Equilibrium Determinacy," Tinbergen Institute Discussion Papers 06-025/2, Tinbergen Institute.
  3. Hung, Fu-Sheng, 2005. "Optimal composition of government public capital financing," Journal of Macroeconomics, Elsevier, vol. 27(4), pages 704-723, December.
  4. Andreas Schabert, 2006. "Central Bank Instruments, Fiscal Policy Regimes, and the Requirements for Equilibrium Determinacy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 742-762, October.
  5. Schreft, Stacey L & Smith, Bruce D, 2002. "The Conduct of Monetary Policy with a Shrinking Stock of Government Debt," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 848-82, August.
  6. Stacey Schreft & Bruce Smith, 2008. "The social value of risk-free government debt," Annals of Finance, Springer, vol. 4(2), pages 131-155, March.
  7. Gomis-Porqueras, Pere & Haro, Alex, 2003. "Global dynamics in macroeconomics: an overlapping generations example," Journal of Economic Dynamics and Control, Elsevier, vol. 27(11), pages 1941-1959.
  8. Pedro Gomis-Porqueras, 2000. "Global Dynamics In Macroeconomics: A General Equilibrium Example," Computing in Economics and Finance 2000 217, Society for Computational Economics.

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