Japan’s Paradox of Banknotes

While cash transactions in Japan have been declining for some time, albeit from a high base, the reduction in opportunities to pay in cash and the increased use of ‘stay at home consumption’ during the pandemic has accelerated this decline. At the same time the ratio of banknotes to GDP has risen very significantly.

The Bank of Japan (BOJ) has issued a paper considering Japan’s version of this cash paradox. The paper looks at the long term use of cash and how this has changed during the pandemic.

While Japan has a propensity to prefer cash, its cash to GDP ratio was about 16% pre-pandemic compared with the US, about 8%, and the euro area, about 11%, the share of transactions made in cash has been declining. The BOJ says this is because of a decline in opportunities to pay in cash due to the spread of cashless payment methods. The share of cashless payments in private consumption expenditure has risen from 20% in 2016 to about 29% in 2020.

Why do people hold cash?

The paper explains that cash in circulation is determined by the need for cash for transactions, which usually follows the business cycle, and non-transactional demand. Non-transactional demand is driven by factors such as: The cost of holding money. If interest rates are low, then the holding value as cash rather than in interest-bearing assets feels less significant.

People’s confidence in the economic outlook and the financial system. The link between crisis such as the 2008/9 global financial crisis and an increased demand for cash is clear.

What are called ‘structural factors’ such as confidence in the political and economic system, the demographic profile of the population, the density of the ATM network and public safety.

How much money do you carry?

The BOJ’s opinion surveys on the general public’s views and behaviours asked this question, controlled by age and income, and estimated the difference in probability that respondents would carry 30,000 yen or more. All age groups were compared with 20 year olds.

30 and 40 year olds were only 1% more likely to carry that much or more but, as the age increased from 50 to 60 to 70 year olds, the difference increased and became statistically significant. The data also suggested that while preferences change with age, one cannot assume that today’s less cash generation will continue to be less cash as they get older.

Japan has a relatively old population and it is clear that this is an important reason for Japan’s high level of cash use.

Changes since the pandemic

The pandemic led to a reduction in the consumption of contact intensive services and an increase in ‘stay at home consumption’. Inevitably this reduced the opportunities for cash payments. This was boosted by the government and businesses, which ran point reward programmes to encourage people to use contactless payments.

The BOJ ran a study that focused on the difference in changes in 1,000 and 10,000 yen banknotes in circulation during the pandemic. It found that transaction demand fell in line with Japan’s states of emergency, dropping in Spring 2020 and early 2021 (but overall transaction demand has continued to increase during the pandemic, recovering these drops).

BOJ carried out a simple panel regression based on data for Japan, the United States and the euro area to gauge the impact of the public health measures on banknotes in circulation. It used Oxford University’s Stringency Index (stringency of pandemic restrictions) and the Services Purchasing Managers’ Index measure of economic activity and found a positive and statistically valid correlation. The stricter the public health measures were, the higher was the growth rate of banknotes in circulation.

Although each country is different, explanations for the results included that while economic activity has dropped, uncertainty has increased due to the impact of the pandemic, the length of time it has gone on, restrictions on opportunities to access cash (meaning people withdrew more when they could) and deposit cash.

Further research used mobile phone location data to establish the extent of the ‘stay at home rate’, controlled for business sentiment and Japan’s special cash payments programme that was run in June and July 2020. It found that while cash issued increased, cash deposited decreased. It also used dummy variables for Japan’s states of emergency.

During the first state of emergency, cash issues increased, and cash deposits decreased, but during the second state of emergency there was not a statistically significant difference. This suggests by the second state of emergency Japan’s population was accustomed to the new environment.

Final word

At first reading this piece of work suggests Japan’s cash paradox before and during the pandemic has mirrored closely those of other countries, albeit starting from a higher level of cash usage. It highlights though, some interesting points.

It confirms the impact of ‘stay at home consumption’ and pandemic restrictions but shows that the disruption of pandemic measures reduces over time.

The paper lays out the important role of Japan’s older age profile and financial uncertainty in maintaining the place of cash, but questions whether it is the old or old age that drives the preference for cash.

It would be good to have clarity about what the BOJ’s says about the spread of cashless payment methods reducing opportunities to pay in cash. If this is the rise of e-commerce, then that makes sense. If it is the adoption of cashless payments at the point-of-sale, then it is less clear.