Determinants of Currency in Circulation in Hungary1
This note reviews various factors that may help explain the increase of currency in circulation. In Hungary—like in most countries with a few notable exceptions—currency in circulation per capita and in percent of GDP has increased over time, despite the availability of more efficient non-cash payment and savings instruments. While this can be attributed to higher real incomes as well as low interest rates and inflation, in Hungary the increase in cash holding also appears to coincide with the introduction of the financial transaction tax in 2013.
1. The note is structured as follows. First, we describe general trends in cash usage and then in Hungary and its regional peers. Second, we discuss main factors driving the demand for cash as suggested by the literature. Special attention is paid to factors and measures that have likely affected cash usage in Hungary. Third, building on the literature, we estimate both a panel version as well as a univariate model for Hungary. The final part concludes.
A. General Observations on Currency in Circulation
2. Currency in circulation—here the terms cash and paper currency are also used interchangeably—is a subset of money, which primarily performs the functions of means of exchange and store of value.2 In principle, the decision to use cash instead of non-cash alternatives should reflect a cost-benefit analysis. The main benefits of using cash are: (i) liquidity and reliability as it, per definition, is legal tender;3 (ii) convenience for small transactions; and (iii) anonymity.4 On the other hand, the main cost of using cash is that it does not yield a return in the form of an interest rate. In addition, cash handling is costly, especially when the sunk costs of alternative electronic payment instruments have already been made.5 Since currency in circulation has increased in most countries, this suggests that cash may have gained importance as a store of value (Bech et al., 2018), likely facilitated by low—in some countries even negative—nominal interest rates.
3. The amount of cash in circulation may indicate trust in the currency and the financial system. The level of cash partially reflects the degree of trust and confidence in the currency, particularly if it is used as a savings instrument. High level of foreign currency (FX) denominated cash compared to local cash—i.e., high level of “dollarization”—implies lack of trust. On the other hand, high levels of cash in circulation could also reflect lack of trust in the financial system. This can happen during and after a systemic banking crisis; in periods of high risks and uncertainty about collection of credits, which motivates more reliance on prompt cash payments; or in case the cost of non-cash services is prohibitive, including due to taxes. Furthermore, cash may also dominate if the shadow economy is substantial.
4. The use of cash has important consequences for the economy, notwithstanding the fact that these changes often are gradual and thus frequently ignored in the short run. In the long run, the use of cash, depending on the availability of non-cash alternatives, affects transaction costs and thus the efficiency and competitiveness of the economy, which may not always be adequately captured by standard measures.6 The Hungarian Central Bank (Magyar Nemzeti Bank, MNB) has thus suggested various initiatives to make the payment system more efficient.7 Furthermore, in the medium term, increased use of electronic payments may help reduce the shadow economy (EY, 2017). In the short run, cash influences the calibration of monetary operations and the seigniorage.8
5. Currency in circulation in percent of GDP has been increasing in most countries, including in Hungary, despite new technologies which increased the efficiency of non-cash payments. The use of cash seems to be declining only in countries where forceful efforts have been made to promote non-cash alternatives. Sweden is a case in point, where cash in circulation has continuously been declining to below 1½ percent of GDP. In contrast, in Japan—with a long period of very low interest rates and inflation—the trend has been increasing and now currency in circulation exceeds 18 percent of GDP.
Cash in Circulation in Hungary
6. In Hungary, currency in circulation in percent of GDP has doubled since 2004, and now exceeds 14 percent of GDP. After the global financial crisis, cash in percent of broad money (M3) began to increase, but this trend has recently begun to decelerate. While the introduction of the financial transaction tax coincided with increasing use of cash since 2013, efforts to reduce the shadow economy may have contributed to the recent deceleration in the use of cash. Comparing Hungary to regional peers, only the Czech Republic has a higher amount of cash holdings in Euros per capita (Figure 1), partially due to higher income per capita. The Euro Area (EA) and Switzerland have higher amounts of paper currency per capita in Euros, but in part due to the much higher income per capita, and in part because their bank notes are also widely used by non-residents outside of the country of origin.
Figure 1.Currency in Circulation in Selected Countries
B. Typical Determinants of Cash Usage
7. Income, interest rates, and inflation are standard determinants of cash demand. In general, cash in circulation tends to increase when income per capita increases (income effect). Cash holdings are also affected by the opportunity costs of not holding alternative payment and savings instruments (substitution effect). Specifically, higher interest rates on alternative assets increase the opportunity costs of holding cash and thus reduce the demand for cash. Higher inflation may have an ambiguous impact on demand for cash. On one hand, higher inflation may increase demand for cash for payment purposes, as goods and services become more expensive. On the other hand, the opportunity cost of holding cash becomes higher, as the value of other assets may increase.
8. To explain differences in both trends and levels across-countries, the standard determinants should ideally be supplemented with additional factors. Economic policy uncertainty and financial sector stability may impact the preference for cash, as previously noted. Moreover, a broad range of governance policies could potentially affect the use of cash. They may include better rule of law, control of corruption, effectiveness of the government, ethics of private firms, etc., as these components all affect trust in the government and the banking system. Furthermore, the structure of the economy, including historical and institutional factors, matter. This can be partially captured by socio-economic factors, level of education, income inequality, access to the internet, and the structure of the economy. For example, if tourism or agriculture account for a large share of the employment, there may be greater reliance on cash (Alonso et al., 2018). Finally, demographic factors may also influence the use of cash, as older people tend to be less inclined to accept new payment instruments. In short, both the level and the trend of cash in circulation reflect numerous country specific factors, with the main ones summarized in Table 1.
|Impact on currency in circulation when left‐ side variable increases||Comment||Proxy indicator|
|Income per capita||+++||Income effect||CDP per capita|
|Interest rates||‐‐||Substitution effect||Money market rates or yields of benchmark government securities|
|Inflation||‐‐ / +||Reduces value of cash, but increases the need for transactions||CPI|
|Economic risk and uncertainty|
|Economic policy stability||+/‐||Trust in currency and the sovereign, but likely also more trust in financial system||Economic policy uncertainty indices (global, regional, and domestically) Indices for sovereign and currency crises|
|Financial sector stability||‐‐||Trust in financial system||Indices for systemic banking crises (Laeven and Valencia, 2018)|
|Share of older population||+||Older population may be reluctant to electronic payment||WB World Development Indicators|
|Economic structure||+||Larger share of economy in agriculture, tourism, higher inequality, and fewer highly educated||WB World Development Indicators|
|Financial deepening||-||Broad money and credit to private sector in percent of GDP||WB Global Financial Development Database|
|Digitalization||-||Easier access to electronic payments||WB Global Financial Development Database|
|Governance indicators||-||Rule of law, government effectiveness, control of corruption, ethics of private firms, etc.||World Wide Governance indicators, WB Doing Business, Global Competitiveness Index|
9. A traditional money demand function can easily be converted to a cash demand function and be elaborated with additional pertinent factors. Demand for broad money typically captures transaction, precautionary, and speculative motives. Its most basic form is often described by equation (1). The real stock of money increases with income and declines when the interest rate increases. This formula can be converted to a demand for cash equation and be elaborated by the various factors described above, as indicated in equation (2). Obviously, some of the determinants are interdependent.
- (1) M/P = L(Y,r)
- (2) Curr/P = L(Y, r, P, Risk&Uncertainty, Demographics, Socioeconomic, Governance)
10. Empirical evidence supports that cash holdings are correlated with the standard explanatory factors. Using a large panel of countries not affected by “dollarization,” Jobst and Stix (2017) found that cash holdings per capita in real terms have continued to increase in recent years. This has been partially explained by higher average income (GDP per capita) and lower interest rates. Nonetheless, they also found that financial crises helped explain the increase in cash holdings, which they contributed to the accompanying greater uncertainty. Lybek and Dybczak (forthcoming) found, using a broader sample, that the influence of systemic banking crises was less pronounced, but was stronger in individual countries impacted by a systemic banking crisis. Jobst and Stix (2017) did not find that changes in the size of the shadow economy impact the demand for cash. Using a broader range of governance indicators to capture trust and efficiency of governments, Lybek and Dybczak (forthcoming) found that some of these indicators help explain cross-country effects, while others, like perceived corruption, was only significant in some countries.9
C. Hungarian Specific Factors
Financial Transaction Tax
11. The impact of the financial transaction tax introduced beginning 2013 has been widely debated. The question was whether the tax on cash withdrawals would spur the use of electronic transfers or instead, cause an increase in circulating cash (Ilyés et al., 2014).10 The tax has since been amended several times. Effective February 2014, the incidence on cash was significantly reduced by allowing two free ATM withdrawals per month not exceeding in total HUF 150,000 (about €450). The current tax rate is 0.3 percent for financial transactions and 0.6 percent for cash withdrawals (not covered by the above-mentioned exemptions) that are above HUF 20,000 by physical persons. The tax is capped at HUF 6,000 (about €19) per transaction (but no cap on large cash withdrawals). The tax on payments by credit cards is a flat fee of HUF 800 per card per year (HUF 500 in the case of the special contactless cards). Banks are not allowed to directly charge the client for the financial transaction tax on ATM withdrawals, but they recover it in other ways. Total revenue from the financial transaction tax amounts to about 0.5 percent of GDP, of which the bulk are on corporate transactions. Beginning 2019, all transactions by individuals below HUF 20,000 were exempted in order to promote the forthcoming instant retail payment system.
12. The introduction of the financial transaction tax in 2013 coincides with increased use of cash in Hungary. Basic econometric tests that were conducted suggest that there was a structural break in currency in circulation in percent of GDP, just before the financial transaction tax was introduced, as the population was expecting the tax and tried to avoid its impact.11 The tests were based on monthly data, where GDP was annualized by splitting quarterly GDP equally on the three months of the quarter.
13. Hungary has introduced comprehensive measures to reduce the shadow economy, which may have contributed to the recent decelerated growth of currency in circulation. In September 2014, electronic cash registers with remote audit capability became mandatory and the coverage of the activities requiring them has since been gradually broadened (OECD, 2019). Since July 2018, all VAT registered tax payers must submit invoices with at least HUF 100,000 VAT content in real-time. These efforts help shrink the shadow economy12 (and tax evasion) as well as the use of cash. Consequently, VAT revenue collection has consistently surprised on the upside in recent years.
14. Cash is primarily used by households, but also by small- and medium-sized enterprises (SMEs) and even larger corporations. According to data from the electronic cash registers, the share of cash transactions—both in volume and value—are gradually declining but still account for the majority (Table 2). Ilyés and Varga (2015) found that the preference for cash tends to be higher for those with only primary education, the young and elderly, the unemployed, students, as well as the rural population. Cash payments are also popular among Hungarian corporations.13 If their income is more cash-based, they are more inclined to use cash to pay their expenditures, including salaries. It is noteworthy that given their already high use of cash, in 2017 about 73 percent of surveyed Hungarian micro-, small-, and medium-sized enterprises reported that the financial transaction tax did not affect their payment practices (Belházy et al., 2018).
|(Percent, unless otherwise indicated)|
|Number of transactions, billions:||3.63||3.74||3.82|
|Value of transactions, HUF billions:||9,134||9,780||11,011|
New Instant Retail Payment System
15. Hungary is planning to introduce an instant retail payment system in March 2020. It will cover credit transfers up to HUF 10 million (€31,250), which will be settled within 5 seconds (compared the 10 seconds being the European maximum benchmark). It only requires having a mobile phone number within the European Economic Area (EEA) or an email address, and a domestic tax identification number. The system is currently being tested to ensure its reliability. In contrast to other countries, the system is mandatory for all domestic banks. To the extent its pricing is appealing,14 and it proves reliable, it should help reduce the number of cash transactions. However, the fact that transactions over HUF 20,000 will remain subject to the financial transaction tax may impede its success.
16. The distribution of banknote denominations can be used to gage the extent to which cash is used as a savings instrument. In the case of Hungary, the share of the volume (value) of the two largest denominations—HUF 20,000 (€60) and HUF 10,000 (€30)—has since 2010 increased from 56 (91) to almost 70 (over 94) percent of all issued banknotes (Figure 2). These denominations, however, are within the typically recommended range.15 Moreover, they are smaller—even when compared to GDP per capita—than the large denominations in Switzerland (CHF 1,000), the Euro Area (€100), and the USA ($100).16
Figure 2.Share of Bank Note Denominations in Hungary, 2010–2019
17. Hungary’s new retail government bond (MÁP+) was intended to also absorb cash but has thus far only had a limited effect. The MNB estimates that less than 10 percent of the purchased MÁP+ have substituted cash. From June to end-September, the total issued MÁP+ amounted to about 4½ percent of GDP. Thus, it seems that cash hoarders are not willing to give up their cash even for the handsomely remunerated, but electronically registered, 5-year bond with the annual average yield of about 5 percent. Nonetheless, MÁP+ has only been introduced in June 2019, therefore the impact on cash could become more pronounced later, when the bond becomes more popular among those depending more on cash.
D. Stylized Facts on Cash Demand in Hungary
18. Developments in income per capita, interest rates, and inflation strongly correlate with use of cash in Hungary.
- GDP per capita in Euros (deflated by Euro Area inflation) has increased by over 50 percent (24 percent) since 2005, while cash in circulation in percent of GDP has almost doubled and cash in Euros per capita has almost tripled. Currency in percent of broad money also appears to be correlated with real GDP growth per capita, particularly after the global financial crisis. However, this may also be caused by lower interest rates and inflation.
- Nominal interest rates have been declining in Hungary, which has coincided with higher cash holdings. Interest rates declined after the transition to a market economy, as inflation also waned, and again as the recovery following the global financial crises gained traction. The declining interest rates are correlated with larger cash holdings, particularly compared to broad money. Even more striking is the marked shift from savings deposits to current accounts.
- Inflation has come down, coinciding with increased cash holdings. Inflation declined after the transition and further after the global financial crisis. All other things equal, inflation should have a similar impact on holding cash and bank deposits. However, there is a secondary effect, as more cash is needed in case of very high inflation to conduct a similar amount of real transactions. But this is less important, particularly when prices are broadly stable. More important is the fact that the lower the inflation is, the lower is the opportunity cost of holding cash, hence the stronger the incentive to hold cash, as long as the risk for theft etc. is diminutive.
- Real interest rates have declined, particularly since 2016, hence enhanced the incentives to hold cash compared to bank deposits. Hungary’s real interest rate is currently lower than in Sweden and the Euro Area (EA). While both nominal interest rates and inflation began to decline in 2011, it was only in late 2016 that the real interest became negative. Hence an element of money illusion or other factors could be in play, as cash in circulation began to accelerate already in late 2012. Around 2016, the growth of cash in circulation appears to have begun to slowly decelerate again. The former coincided with the introduction of the financial transaction tax in 2013, while the latter could reflect recent efforts to reduce the shadow economy.
Figure 3.Currency in Circulation and GDP per Capita, 1998–2019 Figure 4.Currency in Circulation and Nominal Interest Rates Figure 5.Currency in Circulation and Inflation Figure 6.Currency in Circulation and Real Interest Rates
19. Following the literature, we estimated the impact of traditional factors and policy variables on the demand for cash. Following Jobst and Stix (2017), a generic equation (3) was applied to a small panel of EU countries and then to individual country data. In addition to Hungary, the panel included Bulgaria, Croatia, Poland, Romania, Czech Republic, Sweden, Norway, Denmark, and the UK during the 2000–2018 period. While the results discussed in this note focus on cash holdings per capita, various indicators for cash were used as a robustness check, including currency in circulation deflated by inflation (CPI) per capita, in Euros per capita, in percent of GDP, and in percent of broad money. Different proxies for real income were used: real GDP per capita, GDP per capita in Euros including deflated with EA CPI, and GDP per capita adjusted for purchasing power (PPP adjusted). For nominal interest rates we tried the 6-month money market rate, 5-year government bond rate, and the bank deposit rate. For inflation we used the national consumer price index (CPI). For governance, socio-economic and demographic factors, we tried those indicated in
Where CurrencyRit represents a natural logarithm of currency in circulation in per capita terms, IncomeRit is a natural logarithm of per capita real income, Interestit represents interest rate and Inflationit is CPI inflation. A dummy variable indicate a systemic banking crisis is represented by BankCrisesit. Control of corruption, rule of law and regulatory quality are captured by Corruptionit, Lawit and RegulatoryQit, respectively.
20. The standard explanatory variables also worked, as envisaged by the literature, when applied to this set of countries. Focusing on the fixed effects panel estimates (Table 3), the income elasticity was estimated and, as expected, was positive and significant. The semi interest rate elasticity was negative but not always significant. This is in line with our priors and economic theory. The impact of inflation on cash demand seems ambiguous, as expected: it was not significant and sometimes slightly positive or negative, depending on the specification. The impact of systemic bank crises was small and not statistically significant. Finally, improved rule of law, higher regulatory quality, and better control of corruption seemed to reduce demand for cash. But none of these factors were found to be statistically significant in this panel. We assume that most of the demographic and socio-economic factors are slow moving and thus captured by the fixed effects and hence not investigated further in this paper.
|legend: * p<.1; ** p<.05; *** p<.01|
|CurrencyR||… Natural logarithm of real currency holdings per capita.|
|IncomeR||… Natural logarithm of real income per capita.|
|Interest||… Short‐term interest rate.|
|Inflation||… CPI inflation.|
|BankCrises||… Systematic bank crises.|
|Corruption||… Control of corruption.|
|Law||… Rule of law.|
|RegulatoryQ||… Regulatory quality.|
21. A similar univariate model was estimated for Hungary. The estimations suggested that the income effect was strong and positive (Table 4). The impact of the interest rate seemed negative and significant. In contrast to the panel regression results, the impact of inflation was estimated to be slightly positive. The results also suggested a high and significant response of cash demand to the index for control of corruption and a somewhat lower response to changes in the index for the rule of law.
|legend: * p<.1; ** p<.05; *** p<.01|
|CurrencyR||… Natural logarithm of real currency holdings per capita.|
|IncomeR||… Natural logarithm of real income per capita.|
|Interest||… Short‐term interest rate.|
|Inflation||… CPI inflation.|
|Corruption||… Control of corruption.|
|Law||… Rule of law.|
|After_2013_DUMMY||… Dummy variable indicating years 2013 and beyond.|
22. Demand for cash seemed to be more responsive to changes in income in Hungary after 2012, when allowing for capturing the impact of the financial transaction tax. Special attention was given to developments before and after 2012 (the transaction tax was introduced in 2013). For this purpose, we expanded equation (3) by introducing interaction terms between each standard explanatory variable (real GDP per capita, short-term interest rate, and inflation) with a dummy variable identifying years 2013 and beyond. Figure 7 shows: (i) the real currency in circulation per capita; and (ii) the fitted-line based on coefficients only estimated on data from 2000–2012, i.e., before the financial transaction tax. The difference between the two lines is about HUF 100,000 per capita. This appears striking, confirming our hypothesis that the financial transaction tax contributed to a higher use of cash. It also supports our prior that the previously identified structural break coincided with the introduction of the financial transaction tax.
Figure 7.Demand for Real Cash per Capita: Actual vs No Financial Transaction Tax
23. The introduction of the financial transaction tax appears to be a prime example of how even a relatively modest change of taxes and incentives can significantly influence behaviors. In addition to the traditional explanatory variable of income per capita, interest rate, and inflation, it seems that the financial transaction tax played a significant role in explaining the increase in cash in circulation. While cash in percent of GDP began to accelerate after the global financial crisis, it really took off around the time of the introduction of the financial transaction tax beginning 2013. Statistically, there is a clear structural break at that time. It looks as if this tax contributed to the increase in the use of cash, at the cost of the generally more efficient non-cash alternatives. In recent years, tax administration has improved, which may help explain why the trend recently has been slowly decelerating.
24. Experience from other countries suggests that the use of cash is persistent (e.g., Jobst and Stix, 2017; and Bech et al., 2018), despite the development of more efficient alternative payment instruments, unless strong policies to promote non-cash are in place. Widespread use of paper currency may impede the development of financial sector and non-cash payment systems, as it raises the transaction cost of the economy and hinders the efforts to formalize the grey economy. It will be interesting to see how successful the envisaged instant retail payment system will become, given that only transactions below HUF 20,000 are exempted from the financial transaction tax.
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Jarmuzek, Mariusz; andTonnyLybek,2018, “Can Good Governance Lower Financial Intermediation Costs,” IMF Working Paper WP/18/279, International Monetary Fund, Washington DC.
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Krüger, Malte; andFranzSeitz,2014, Costs and Benefits of Cash and Cashless Payment Instruments: Overview and initial estimates, Study commissioned by the Deutsche Bundesbank, Frankfurt.
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Lybek, Tonny; andKamilDybczak, forthcoming, “Why is Cash in Circulation Increasing in So Many Countries? Some Stylized Facts,” IMF Working Paper, Washington DC.
Medina, Leandro; andFriedrichSchneider,2018, “Shadow Economies Around the World: What Did We Learn Over the Last 20 Years?” IMF Working Paper WP/18/17, International Monetary Fund, Washington DC.
MNB, 2019A, Competitiveness Program in 330 Points, Magyar Nemzeti Bank, Budapest.
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Prepared by Tonny Lybek and Kamil Dybczak.
In this paper, we look at use currency in circulation outside the central bank (not outside commercial banks).
In Hungary, there are no limits on the number of respective banknote denominations that venders are obligated to accept. Recently, some countries have permitted stores not to accept cash (e.g., in Sweden, some shops, museums and restaurants now only accept card or mobile payments, while in Denmark some stores can refuse cash during night times to reduce the risk of crime).
The new blockchain technology, for instance, now also offers anonymity.
In Germany, Krüger and Seitz (2014, p. 109) estimated that cash and cashless payment services accounted for at least 2 percent of GDP without considering qualitative factors. Achord et al. (2017) estimated that the costs of cash handling in advanced economies was around 0.45 percent of GDP and up to 3 percent of GDP in India. Zandi et al. (2013), covering 57 countries during 2008–12, estimated that electronic payments alone contributed to real GDP growth by, on average, 0.2 percentage points for advanced economies, and 0.8 percentage points in emerging markets. Zandi et al. (2016) broadened the analysis to 70 countries during the 2011–15 period and assessed that increased use of card payments alone annually contributed to additional 0.1 percent of GDP due to improved efficiency.
Ilyés and Varga (2016) found—applying a general equilibrium model to Hungarian data—that substituting cash with debit cards, in successive order, would: (i) improve the efficiency or resources already available; (ii) reduce the deadweight loss of cash services; and (iii) release resources from the costlier cash payments.
The Hungarian Central Bank’s Competitiveness Program in 330 Points (MNB, 2019A) includes improve electronic payment solutions (point 22), support instant payment services (points 25 and 26), and incentivize banks to reprice retail payment services (point 27).
Rogoff (2016, page 2) noted: “The effect of curtailing paper currency on tax evasion alone would likely cover the costs of profits from printing paper money, even if tax evasion fell only by 10–15%. The effect of illegal activities is probably even more important.” Moreover, he argued that paper currency—particularly large denominations— hampers the use of negative interest rates as a monetary policy instrument.
Generally, measures to improve the rule of law, predictable contract enforcement, and thus financial intermediation can have sizable payoffs, not just in using non-cash payment and savings instruments, but also by lowing the net interest margins of banks. See Annex II in IMF Country Report 18/252 and Jarmuzek and Lybek (2018).
Some market observers have noted that the financial transaction tax initially was considered a source of revenue that would compensate for negative externalities of the financial system following the global financial crisis.
LR, Wald, and cumulative sum tests for parameter stability were used.
Medina and Schneider (2018), for instance, estimated that the share of the shadow economy already declined from about 25 percent of GDP in 2000 to about 20 percent in 2015.
In 2007, regulation was introduced requiring corporations to have internal rules on cash handling. In 2009, it was tightened, limiting cash holdings to 1.2 percent of the revenue of the previous year. This regulation was gradually eased and by end-2012, companies could again set their own limitation on cash holdings.
The prices of non-cash payment services relative to net wages, are high by international standards, even when adjusting for the financial transaction tax (Chapter 4 in MNB, 2019B)
In 1980, L. C. Payne and H. M. Morgan suggested the D-metric system to determine the denomination of coins and banknotes. The largest denomination should be within two to five times the daily net average pay, and the second largest denomination within the daily net average pay and twice that amount.
The Federal Reserve has stopped issuing $10,000, $5,000, $1,000, and $500 notes, while the ECB stopped producing the €500 bills in 2014.