Pay Me Enough and I Will Pay Attention: Currency Demand at Zero Interest Rates

Abstract

Following the implementation of negative policy rates, interest rates on bank deposits reached historic lows, with values close or equal to zero. This is the first paper to empirically investigate the implications of this new environment for currency demand. We find evidence of a structural break when interest rates on deposits approach zero. Exploiting time, bank and banknote denomination variation, as well as exogenous reforms that affected currency payments and holdings, our analysis points towards a major role played by higher transactions rather than by store-of-value demand. We show how our empirical evidence can be rationalized by a simple extension of a currency inventory model, in which agents turn inattentive to deposits interest rates when they approach zero. This new mechanism could help explain the so-called paradox of currency whereby, even if the volume of transactions decreases, currency balances increase.

Keywords: financial stability, monetary policy, negative interest rates, deposits, zero lower bound, money demand, inattention.