Cashless Society Supports Friedman’s Theories

An undergraduate study in Nigeria has been published by the Munich Personal RePEc Archive which considers what happens to money, monetary policy and financial assets ¹ when cash demand falls. While highly theoretical, it does not touch on the practicalities of implementation such as financial inclusion, the necessary technology infrastructure or public acceptance, it does point towards some useful findings for policy makers.

Economic theory: the paper reminds us of some theory, the opposing views of John Maynard Keynes and Milton Friedman and the development of new approaches in more recent times.

Keynes argued that the need for money is driven by transactions, preventative and speculative reasons. Changes in money demand impact overall economic demand and inflationary pressures. Friedman saw money supply as key with fluctuations being the primary cause of inflation requiring prudent money supply management as key.

The latest thinking argues that cash is not important in today’s economy. The priority of policy makers should be a focus on controlling the disparity between the actual value of the interest rate and its exogenously determined neutral level, rather than solely considering the nominal interest rate itself.

The move towards being cashless: as the economy becomes cashless, the transaction velocity of cash will increase. Transaction velocity is a measure of cash efficiency, so this means cash will be working increasingly hard.

A more unexpected finding was how going cashless effects price determination. As real cash balances reduce and get close to being zero, asset prices remain responsive to monetary policy. In other words, monetary equilibrium prices do not necessarily converge to their non-monetary equilibrium counterparts when real balances vanish.

The importance of this is that in a cashless economy, if central banks carefully manage the money supply available to individuals, they will be able to control and stabilise the price level. Adjusting the money supply allows the desired price level to be controlled even in a cashless society.

Final word: although a highly theoretical piece of work, it would be interesting to see whether the modelling of central banks reflects these conclusions.

1 - ‘Analysis of cashless economy, demand for money and price determination: A possibility for implementation in Nigeria.’ EKPEYONG, PAUL University of Ibadan.