Alternative Monies and the Demand for Media of Exchange

Prepaid cards, cash cards, electronic purses, smart cards these are but a few of the elements inthe revolution now taking place in monetary systems around the world. At that movement's heart is the emergence of a new value transfer system where alternative monies are offered toconsumers through the miracle of electronics. There are many stories in the business press about the general enthusiasm for these new forms of money. According to the hyperbole from marketing reps from this side of the financial community, currency and demand deposits soon will be endangered species. Consumer acceptance is alleged to be high, and cost efficiency associated with the new technology is expected to be substantial. Yet, as Wenninger and Laster (1995) suggest, "to succeed, an electronic purse system will need to offer enough features of value to its three constituencies consumers, merchants, and issuers to induce them to bear the cost." Most arguments in favorof these media of exchange can be viewed as a reaction to the rising costs associated with current check clearing and on-line credit systems. Data are scare. However, the cost advantages to the banking system of a movement from paper check to debit cards is alleged to be in the range of 50%. Off-line pre-paid cards are expected to reduce the cost of clearing transactions, handling cash and reducing fraud for merchants. To read the press, the consumer is equally enthusiastic. However, the economic rationale for this consumer enthusiasm is a bit unclear. Each application of the emerging electronic technology has been different in important ways. The universal receptivity to alternative monies may be more a good marketing ploy than good economics. To understand consumer reaction requires a careful analysis of the desirability of any one of these alternative technologies in terms of its impact on consumer cash management costs through changes in transaction patterns, average money holdings, and total transaction costs. The authors attempt this analysis by investigating the effect of variations in the number and type of monies on consumer transactions demand using a Baumol-Tobin type model of moneydemand. They investigate the behavior of a representative consumer facedwith a choice ofmonies with which to transact, and ask how variations in the characteristics of these monies will affect the consumer choice of transaction vehicle, transactions frequency, and average balance in various media. The results are surprising. Variations in the cost of transfer, interest rates, and the acceptabilityof alternative media have surprising effects on consumer choice. In general, the cost of using amedium of exchange determines whether it will be used and for which goods it will be traded. The choice of medium of exchange, then, has a direct effect on both the average holdings ofdifferent types of money and their transition frequencies. It suggests that efforts by banks to alter the costs of using a particular form of money may cause consumers to change their exchange behavior, shifting it sometimes rather dramatically. The authors demonstrate the impact of these results with an example of a stored value card, and its competitive position vis-a-vis the two most common media of exchange. This transfermedium offers some of the features of demand deposits such as ease of transfer and generalacceptability. At the same time, it avoids the fixed costs of a checking account while offering noreturn on average balances. The authors have observed that households tend to use the high-interest medium of exchange to buy the good that constitutes the larger share of its income. Given the relative rates of return on stored value cards and checking account balances, the former is unlikely to dislodge the use of checks for purchases. On the other hand, the stored value card represents a credible threat for cash transactions. Here, rates of return are both zero, although it can be argued that cash may have a negative return due to theft. Given their new ease of use, smart cards could also be competitive from a transfer fee perspective. In fact, given the lower cost of transfer into the card, it may dominate cash in the near future. While the foregoing results apply to the individual household, aggregate results often are moredifficult to prove. For example, an increase in the cost of obtaining a medium of exchange,reduces the number of households using the exchange, but raises average balances for thosehouseholds that continue to use it. Therefore, efforts by banks to lower the costs of using aparticular form of medium of exchange may well reduce the average holding of that medium. Also, interest rates generally have ambiguous effects on money holdings. Determining whetheran increase in a particular interest rate will raise or lower holdings of a particular form of money requires a case by case analysis, and the conclusions can change from one day to the next with changes in other parameters of concern to the household. The authors conclude that affecting monetary behavior is no simple matter. As providers ofdifferent monies move from experimentation to implementation, these results offer a warning. The choice of money or monies to be used for transactions purposes is a complex decision. Itdoes not lend itself to simple extrapolation from consumer surveys, and, in fact, may result insubstantially different outcomes than had been presumed.