The Increasing Leverage of Central Bank Cash in Transition to a Cashless Economy – A DSGEM Analysis

Abstract

In this paper, the consequences of a transition to a cashless economy are analyzed within the framework of a DSGE model with demand deposit money creating business banks. The analysis shows that such a transition lowers the costs of using money as a means of payment and increases therefore steady state GDP. The out-of-steady state simulation shows that the transition significantly reduces the negative impact of monetary policy shocks and the standard deviations of all macroeconomic variables with exception of the nominal interest rate. Furthermore the analysis displays that the central bank will not lose the instruments to implement its policy goals. However, the transition to a cashless economy leaves the operation mode of monetary policy not unaffected. In such a transition, the central bank must steadily decrease its supply of cash to the economy, since the potential for business banks to create demand deposit money steadily grows. If the cash ratio should approach values close to zero, the central bank still has the possibility to increase the required reserve ratio. However, since a low value of the sum of cash ratio plus reserve ratio reduces the costs of using money as a means of payment and hence increases steady state GDP, this instrument should be carefully employed.

Keywords: Cashless economy, money supply, credit supply, monetary policy, central bank, theory of the bank, business bank, DSGE Model

JEL Classification: E5, E51, E52, E58, E31