Why Did he Demand for Cash Decrease Recenly in Korea? Byoung Hark Yoo Bank of Korea 26. 5 Absrac We explores why cash demand have decreased recenly in Korea. The raio of cash o consumpion fell o 4.7% in 1999 while i had never been under 5% unil hen. The empirical analysis based on he model by Whiesell (1989) shows ha a ax policy ha was firs inroduced in 1999 accouned for mos of he recen decrease in cash demand. The ax policy ha gives ax deducion on credi card purchase o consumers decreased he cos of credi card ransacion and, as a resul, consumers used credi cards where hey used o use cash. Wihou he policy, he raio of cash o consumpion would recover o 5.2% which is around long erm average. Meanwhile, we also found ha he usage of cerified checks ha are used as if he were cash decreased as elecronic paymen including inerne banking increased. 1. Inroducion The raio of cash o consumpion has fallen o 4.6% in 1999, which is he lowes level in Korea. Such decrease in cash demand is ofen old o be due o he increase in alernaive paymen ools such as credi cards. Many people also suspec ha he demand of cash will diminish much furher as he elecronic cash is inroduced and he inerne shopping is widespread hese days. We invesigae he effec of he alernaive money on he cash demand and he reason of he recen decrease in cash demand in Korea. Mos of he lieraure on cash demand shows inconsisen resuls abou he effec of alernaive paymen ool o cash demand. While Kim (1995) argued ha he increase in credi card purchase decreased he cash demand, Kim and Lee (1998) old ha Kim's (1995) resul is no significan wih more recen daa. Bang (2) used a linear rend as a proxy of he rend of alernaive paymen usage and showed ha he expansion of he alernaive paymen usage decreased he cash demand of he whole economy and he firms. Tack (21) repored a lile confusing resul ha he increase in he frequency of credi card usage decreases he cash 1
demand bu he increase in he amoun of credi card purchased does no. The reason why we have inconsisen resuls migh be ha all he empirical sudies are based on he money demand model by Baumol (1952) and Tobin (1956). The Baumol-Tobin model considers money he only paymen insrumen so ha i does no explain he relaionship beween cash and noncash and, as a resul, researchers have chosen ad-hoc explanaory variables o see heir effec on cash demand. In his paper, we used Whiesell's (1989) model which explores he use of cash and checking accoun for paymen and analyzed empirically he recen change of cash demand in Korea. We also sudied on he demand of cerified checks ha is used almos as cash in Korea. The main resuls are following. We found ha he reason of he recen decrease in cash demand was a ax policy relaed o credi card usage. The ax policy which was effecive firs in 1999 gives a ax deducion o he credi card user depending on he amoun of credi card purchases. The policy decreased he cos of credi card usage so ha consumers used credi cards even where hey used o use cash. Wihou he policy, he raio of cash o consumpion would recover o 5.2% which is near long erm average. This paper proceeds as follows: Secion 2 inroduces he paymen sysem of Korea. Secion 3 explains Whiesell s (1989) model o see wha affecs cash demand. Secion 4 esimaes he demand of cash and cerified check. Secion 5 concludes. 2. Small Amoun Paymen Sysem of Korea 2.1. Cash In general, cash demand increases as he economy grows. Therefore, he raio of cash o nominal consumpion or nominal oupu may represen changes of cash demand. Figure 1 shows he cash/consumpion raio of Korea. The firs wo peaks in 197s seem o be relaed o he oil shocks. The hird peak in he mid 199 is associaed wih a policy ha illegalized borrowed or fake name financial ransacions. The raio, never below 5% unil 1998, fell o 4.6% in 1999 and did no recover o over 5%. The purpose of his paper is o explain why he raio remained under 5% since 1999. 2
Figure 1. Cash o Consumpion Raio in Korea % 7. 6.5 6. 5.5 5. 4.5 1999 4. 1971 1976 1981 1986 1991 1996 21 We have banknoes of hree differen denominaions- \1,, \5,, and \1,. The number of denominaion is relaively small and he highes denominaion is jus around $1. As a resul, he use of \1, is dominan in Korea as Figure 2 shows. For a large amoun ransacion, he Korean use cerified check or credi card which will be explained in he nex subsecions. Figure 2. Use of Three Denominaion Banknoes in Korea (in cumulaed sock) 1% 8% 6% \1, 4% 2% \5, \1, % 1987 1989 1991 1993 1995 1997 1999 21 23 3
2.2. Cerified Check Personal checks are no popular in Korea. Insead, cerified checks are widely used for a large amoun ransacion. Differen from cerified checks in America, however, he cerified checks in Korea do no show any prior recipien. Tha is, i funcions almos as cash. Cerified check denominaed as \1, can be wihdrawn a any ATM. However, \1, cerified checks are no as safe as cash because cerified checks are more easily forged han cash. The usage of \1, cerified checks are decreasing as Figure 3 shows. Figure 3. Raio of \1, Cerified Check o Consumpion % 6 5 4 3 2 1 1991Q1 1993Q1 1995Q1 1997 1 1999 1 21 1 23 1 25 1 2.3 Card The usage of credi card is dominan over any oher debi card or prepaid card in Korea. The ransacion amoun of credi card accouns for 98% among all he card ransacions. The credi card purchase has increased a lo since 1999, as Figure 4 shows. This migh be due o a ax policy ha gave ax deducion on credi card purchase. The policy was a firs effecive in May 1999 and revised in January 21 and in January 25. 4
Figure 4. Credi Card Purchase % 12 1 8 6 4 2 1991 1993 1995 1997 1999 21 23 2.4. Inerne Shopping Inerne shopping is also increasing as Figure 5 shows. Ye inerne shopping purchase accouns for a very small fracion of consumpion, compared wih cerified check or credi card. Credi card and online ransfer are he main paymen insrumens in inerne shopping. Elecronic money is no ye widely used. Figure 5. Inerne Shopping % 1.6 1.4 1.2 1..8.6.4.2. 21 1/4 22 1/4 23 1/4 24 1/4 25 1/4 5
3. Theoreical Approaches on Cash Demand 3.1 Baumol-Tobin Model Why do we need cash for ransacion? The firs reason is ha he ime when income happens is no necessarily he ime when we wan o spend. The second reason is ha here is a cos when we wihdraw cash from bank accoun. Based on his reasoning, Baumol (1952) and Tobin (1956) inroduced he following cash demand heory. A consumer deposis her income (Y) o her saving accoun when she ges her income. Spending happens coninuously during a period. She needs cash for ransacion and cash does no provide any ineres. The saving accoun is no used for ransacion bu ineres accrues from i. Whenever she wihdraw cash from her saving accoun, here happens a cos α SC, which is someimes called bank visi cos. Then she chooses he number o visi bank (n) o solve he following minimizaion problem, is Min Y + α SCn n 2n where i s is he ineres rae of saving accoun. The opimized average cash holding is C Yα SC =. 2i S The Baumol-Tobin model does no consider checking accoun, ha is, alernaive paymen insrumens oher han cash. Therefore, i does no fi o explain he effec of noncash o cash demand. 3.2. Whiesell Model Whiesell (1989) suggesed a model which considers boh cash and credi card as paymen insrumens. This secion describes he model and provides us wih heoreical background of he empirical work which is done in he nex secion. A consumer deposis her money (Y) on her checking accoun (D). Some amoun is wihdrawn as cash (C) and he oher is used for check issuing or credi/debi card paymen. For he convenience of analysis, we assume ha credi card is he only alernaive paymen insrumen based on checking accoun. Ineres accrues on he checking accoun by ineres rae, i D, and cos follows when one wihdraws cash from her checking accoun by α DC. 6
Why do we need check accoun oher han cash for ransacion? For a large amoun ransacion, o pay i by credi card or check which is based on check accoun is safer and more convenien han cash. On he oherhand, paying by he alernaive paymen insrumen accompanies cos. Whisell (1989) assumed ha he cos which follows credi card ransacion, which we call credi card cos and denoe by α DG, has he following form: α DG = u + vt where T is he amoun of one ransacion. u is he fixed cos of he credi card cos, such as inconvenience coming from signaure and ime o wai o be auhorized. vt is he variable cos o ransacion amoun. Le F(T) be a funcion represening ransacion amoun per each ransacion and oal expendiure is expressed as follows: Y = F( T ) dt. Consumer pays by cash when he ransacion amoun is less han λ. Over he amoun, she pays by credi card. Figure 6 shows he behavior of her. C = λ F( T ) dt Figure 6. Usage of cash and credi card in Whisell model F(T) C D λ T Le n be he number o wihdraw cash from check accoun. Then he consumer chooses λ and n so ha she minimizes cos coming from holding cash as follows id Min λ, n n 2 λ F( T ) dt + α DCn + α λ DG F( T ) dt. T 7
As one noice, he firs wo pars of he above cos are similar o Baumol-Tobin model. The hird par represens he cos relaed o credi card purchases since F(T)/T can be considered he number of purchasing T amoun. Assuming inerior soluions, we ge he following FOCs: i u D = v + 2n λ i D λ α DC = F( T ) dt. 2 2n Le λ and n be he soluions. Then, we can ge cash demand of Whisell model like his: 1 λ C = F( T ) dt. 2n Even hough he Whisell model is a simple model which does no consider alernaive paymen insrumens oher han credi card, i gives several insighs abou he relaionship beween cash and noncash. Firs, cash demand is a funcion of consumpion and checking accoun ineres rae. This is conrary o he case of he Baumol-Tobin model where cash demand depends on income and saving accoun ineres rae. Second, cash demand is dependen on he change of he credi card cos raher han credi card usage iself. When he credi card cos decreases, ha is, u or v decreases, λ decreases ( λ u, λ v ) 1 and, as a resul, cash demand decreases ( C λ ) 2. Of course, when he credi card cos goes down, credi card usage also increases. Increase in credi card ransacion, however, may no necessarily mean a decrease in he credi card cos. I may resul from he changed relaion beween credi card and oher alernaive paymen insrumen. This is why one migh ge unreliable resuls when cash demand is se o depend on credi card ransacions. The Whisell model argues ha cash demand be a funcion of he credi card cos. Third, he Whisell model implies he same resuls abou debi cards or checks. Like credi card, heir usage is based on checking accoun and hey are more convenien for large amoun paymens. Therefore, we can infer ha cash demand also depends on he cos following debi card or check ransacion. 1 See Whisell (1989) for proof. 2 See Whisell (1989) for proof. 8
Figure 7. Effec of decrease in credi card cos F(T) C D λ 2 λ 1 T Fourh, elecronic money or smar chip money does no fi he Whisell model since i is designed o relieve he inconvenience which comes from small amoun ransacion. However, we can conjecure ha cash demand depends on he cos following elecronic money ransacion. Fifh, he increase in inerne shopping migh decrease cash demand since inerne shopping could decrease offline shopping where cash is used for paymen. In summary, cash demand is a funcion of consumpion, checking accoun ineres rae, bank visi cos, coss following alernaive paymen insrumens ransacions, and inerne shopping. Cash demand increases when consumpion or noncash cos increase and ineres rae or inerne shopping decrease 3. This can be presened as follows: CASH = f ( CSUM, i, α DC, α, E) + + where CASH is cash, CSUM is consumpion, i is ineres rae, noncash ransacion cos, and E is inerne shopping. α DC is bank visi cos, α is 3 As Whisell (1989) poined, he effec of bank visi cos on cash demand is no known in he model. When bank visi cos increases, n decreases and cash demand increases, bu, a he same ime, λ also decreases and cash demand decreases. 9
4. Esimaion 4.1. Cash Demand Based on he Whisell model, we se up an empirical model o esimae cash demand in Korea. We use quarerly daa from 1997:1 o 25:2. All daa can be downloaded from ECOS a Bank of Korea. Several feaures are considered o se up a model. Firs, for a variable ha represens cash demand, we use he cumulaed sock of cash divided by consumpion. This helps us avoid spurious regression problem because boh cash and consumpion urned ou o be nonsaionary in ADF es. Second, we didn consider bank visi cos and inerne shopping since hey are no easily quanified and do no seem o affec cash demand much during he period which we consider. We also didn regard noncash cos excep credi card cos by he same reason. Third, we suspec ha credi card cos affeced cash demand during he period. The problem is ha he credi card cos is no observable and we need o quanify i o do empirical works. We ook he following seps o measure credi card cos. We esimaed he following model for credi card usage: CRD CSUM = D D D 12 FRN.7 +.11 1 +.12 2 +.3 3 + 1. + ε (1) CSUM where CRD is credi card purchase, CSUM is consumpion, D is dummy variables for credi card ax policy (here were hree revisions.), and FRN is he number of credi card franchises. Based on he esimaed resul, we ake he following equaion as credi card cos variable: COST =.11D +.12D +.3D ). (2) ( 1 2 3 Fourh, he credi card insallmen purchase increased a lo from 1998:1 o 2:2. This was due o he decrease in insallmen purchase amoun per ransacion, which implies ha consumers who were in a recession afer he financial crisis paid smaller amoun by credi card. Purchasing small amoun by credi card migh decrease cash demand. Though his effec migh be emporary, we consider his phenomenon. 1
Considering all he poins, we se up he following model for cash demand: CASH CSUM = β + β1i + β2cost + β3inst + γ 1Q1 + γ 2Q2 + γ 3Q3 + ε (3) where INST is insallmen purchase per ransacion and Q i is a seasonal dummy. Table 1 shows he resul of cash demand model. As he heory predics, he sign of ineres rae is minus and ha of credi card cos is plus. As Equaion 2 shows, he credi card cos decreased hree imes, so he plus sign of credi card cos coefficien means he decrease in cash demand. The esimae implies ha cash demand decreased by 2.9 billion won a 25:2 because of he credi card ax policy. Table 1. Esimaion of Cash Demand Consan I COST INST Q1 Q2 Q3 18.46 -.27 85.2.8 1.66.7.32 (.64) (.13) (15.86) (.1) (.25) (.17) (.18) adj.r 2 =.82 D.W.=1.61 Noe: 1) and refer o saisical significance a he 1% and 5% level, respecively. 2) Newey-Wes Heeroskedasiciy Consisen Sandard Errors are in parenheses. Figure 8 shows he effec of he credi card ax policy on cash demand. The doed line represens he cash-consumpion raio which could be wihou he ax policy CASH CSUM ˆβ 2COST ). If here was no credi card ax policy, he cash-consumpion ( raio would rise up o 5.2% in 24. We applied he same model o banknoes and coin and repored he resuls of he denominaion demand in Table 2. I urned ou ha he credi card ax policy decreased he demand of \1, banknoe and \1, banknoe while he demand of \5, banknoe and coin was no affeced. All denominaions showed significan seasonal flucuaions. Differen from oher denominaions, coin showed srong auoregressive propery. This implies ha coins are easily hoarded for changes. 11
Figure 8. Effec of he Tax Deducion on Cash Demand % 6.5 6. 5.5 No Tax Deducion 5. 4.5 CASH/CONSUMPTION 4. 199 1992 1994 1996 1998 2 22 24 Table 2. Demand for Banknoes and Coins Denom. Cons i COST INST Q1 Q2 Q3 adj.r 2 1, 16.1 -.9 55.89.6.8.16.14.51 (.64) (.12) (16.25) (.1) (.31) (.24) (.32) 5,.62 -.7 -.7-21 -5.9.8.15.84 (.3) (.8) (1.8) (51-5) (.1) (.5) (.3) 1,.82.12 3. -.41-5.9.37.39.93 (.4) (.9) (1.24) (41-5) (.1) (.6) (.5) Coin 3).95.1.48.2.4.52.3.67 (.5) (.6) (1.7) (.1) (.1) (.1) (.3) Noe: 1) and refer o saisical significance a he 1% and 5% level, respecively. 2) Newey-Wes Heeroskedasiciy Consisen Sandard Errors are in parenheses. 3) Esimaed wih AR(1). 4.2 Cerified Check As noed earlier, since he highes denominaion in Korea is very low, cerified checks are used for large amoun ransacions. \1, Cerified checks can be wihdrawn in ATMs so ha he wihdrawing cos of \1, cerified checks is same as ha of cash. However, one needs o presen her ID or sign on he back of cerified checks. Also, cerified checks are forged more easily han cash. There is a discussion abou issuing higher denominaion banknoe, such as \1, in Korea. This subsecion explores he usage of \1, cerified checks o ge implicaions for he issue. 12
One can see ha he usage of \1, cerified checks are very differen from ha of cash. The raio of \1, cerified checks ransacions o consumpion is coninuously decreasing and does no show seasonal flucuaions, as shown in Figure 9. This means ha \1, cerified checks are no popular as cash and hey have limiaions o represen he demand of \1, banknoes. Figure 9. Cerified Check and Online Paymen (%) (%) 4 1, 3 2 1 Cerified Check/Consumpion(lef) Online Paymen/Consumpion(righ) 8 6 4 2 1997 1 1998 1 1999 1 2 1 21 1 22 1 23 1 24 1 25 1 Then, why he usage of \1, cerified checks are decreasing? Online paymen including inerne banking could be a reason of ha. Figure 9 shows ha he raio of online paymen ransacions o consumpion is coninuously increasing. We found ha he wo raios have one coinegraion vecor significanly a 1% level by Johansen s es. The esimaed coinegraion equaion is CHK CSUM OLP =.327.22. (62.2) ( 28.9) CSUM where CHK is \1, cerified check ransacion, CSUM is consumpion, OLP is online paymen ransacion, and -values are in parenheses. This equaion shows ha he usage of \1, cerified checks is decreasing as online paymen ransacions are increasing. 5. Conclusion We find ha he cash-consumpion raio fell below long erm average in 1999 and explore wheher alernaive paymen insrumens decreased cash demand in Korea. According o Whiesell s (1989) model, when he noncash ransacion cos decreases, noncash ransacion increases and cash demand decreases. Our empirical resuls show ha he ax policy ha 13
provided ax deducion on credi card purchase decreased he credi card cos and, as a resul, lowered cash demand. In addiion, he ax effec explains mos of falling of cash-consumpion raion below long erm average. This implies ha he recen decrease in cash demand was no due o he echnical progress in alernaive paymen sysem bu due o a governmen policy. The resul of esimaing he demand for banknoes showed ha he credi card ax policy decreased he demand of \1, banknoe and \1, banknoe while he demand of \5, banknoe and coin was no affeced. All denominaions showed significan seasonal flucuaions. 14