Foreign demand for euro banknotes

Laure Lalouette, Alejandro Zamora-Pérez,

Codruta Rusu, Nikolaus Bartzsch,

Emmanuelle Politronacci, Martial Delmas,

António Rua, Marco Brandi, Martti Naksi

Occasional Paper Series

Foreign demand for euro banknotes

No 253 / January 2021

Disclaimer: This paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.

Contents

Abstract		2
1	Research question and objectives	3
2	The drivers of foreign demand	5
	2.1	Literature review of the drivers of demand for cash abroad	5
	2.2	Evidence from banknote demand functions	8
	2.3	Analysis of the determinants of euro banknote net shipments	11

2.4 Cash holdings and currency substitution in CESEE countries:

		evidence from the OeNB Euro Survey	21
3	Estimating the share of euro banknote circulation outside the euro
	area		28
	3.1	Net shipments data	28
	Box 1 Recent developments in the net shipments of euro banknotes:
		the €500 issuance stop and the coronavirus (COVID-19)
		pandemic	32
	3.2 The ECB's external statistics division method	33
	3.3	The seasonal method	34
	3.4 The age of banknotes method	41
	Box 2 First estimates of net cash remittances over time for the euro
		area	43
4	Conclusion: foreign demand, a key to the paradox of banknotes	47
Annex 1: Methodological notes on the data	49
	Net shipments data	49
	Wholesome trade data	49
	Survey of households in CESEE	50
Annex 2: Remittance channels	51
Annex 3: Euro bill tracker	52
Annex 4: A tourist's journey	53
References		54

ECB Occasional Paper Series No 253 / January 2021

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Abstract

In order to understand why there is a continuous increase in euro banknote circulation even though the use of cash for transactions is decreasing in the euro area - a phenomenon known as the paradox of banknotes - the members of the Overseas workstream of the Eurosystem Research Network on Cash (EURECA)1 have conducted a study on the foreign demand for euro banknotes. The results of this study are based on desk research using data collected in the Eurosystem and from other organisations, and using both proven and innovative techniques.

The objectives of this study are to identify the drivers of foreign demand and to estimate the share of euro banknotes circulating outside the euro area. The results provide an insight into the reasons for the increase in banknote circulation. They also show how significant the international demand for euro banknotes is, providing us with a clue to understanding the paradox of banknotes.

The study shows that there are a multitude of factors behind the demand for euro banknotes, for both store-of-value and transaction purposes. In particular, euro cash flows are mainly driven by local-specific determinants, i.e. factors affecting a country's demand for euro (local inflation, economic activity and foreign tourism) rather than external factors (global uncertainty or short-term interest rates in the euro area). On the back of this research, the share of euro banknotes in circulation estimated to be outside the euro area is between 30% and 50% of the total value of euro banknote circulation.

Keywords: euro, banknotes, foreign demand for money, euroisation, currency substitution, hoarding, remittances

JEL classification: E41, E47, E49, E59, F24

1 Eurosystem Research Network on Cash (EURECA).

ECB Occasional Paper Series No 253 / January 2021

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1 Research question and objectives

Prepared by Laure Lalouette, ECB

A currency's international role may, to a certain extent, explain the trends seen in the total value of its circulation. At the end of December 2019, the total value of euro banknotes in circulation was €1,292.7 billion, with an annual growth of 5.0% - the average rate over the past ten years (see Chart 1). Euro banknote circulation is growing continuously, even though it is claimed that cash usage is declining: this phenomenon has been referred to as the "paradox of banknotes" (Bailey, 2009) or the "cash paradox" (Williams, 2012; Jiang and Shao, 2020). However, the euro is not only used for transaction purposes, although other factors underpinning demand have, until now, been insufficiently investigated.

Chart 1

Euro banknotes in circulation

(left-hand scale: EUR billions; right-hand scale: percentages)

Total value euro circulation

Annual growth rate

1,400									10
1,200									9
								8
1,000									7
800									6
									5
600									4
400									3
200									2
								1
0									0
2010	2011	2012	2013	2014	2015	2016	2017	2018	2019

Source: ECB Currency Information System (CIS2) data.

Note: Last observation December 2019.

The steady upward trend for euro banknotes in circulation is not the homogeneous stylised pattern seen for other European currencies. As Chart 2 shows, the value of banknotes in circulation in developed countries may increase, remain stable or decline. Various factors may explain these trends, e.g. the international role of a currency. The Swedish krona, which is mainly used for domestic transaction purposes, shows circulation growth declining over time (Engert et al., 2019). The Danish krone, which is mainly used for domestic transactions and as a domestic store of value, shows stable growth. The euro, which is used for domestic and foreign2 transactions and for domestic and foreign3 store-of-value purposes, shows strong circulation growth. There may be evidence that foreign demand for euro banknotes, both for transaction and for store-of-value purposes, is supporting its circulation growth. The

1. E.g. euroisation, cross-border shopping, travel for leisure or for business.
2. E.g. savings, currency reserves and asset portfolio management.

ECB Occasional Paper Series No 253 / January 2021

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