Does the shadow economy mitigate the effect of cashless payment technology on currency demand? dynamic panel evidence

Paul Marmora and Brenden Mason

Applied Economics, 2021, vol. 53, issue 6, 703-718

Abstract: Recent government attempts at reducing currency demand by promoting cashless payment technology, e.g., subsidies for point-of-sale terminals, have met with mixed success. In this paper, we argue that one reason is the shadow economy: as the size of the unrecorded economy grows, cashless payment technology has a weaker effect on the demand for cash. To test this hypothesis, we analyse a panel of 37 countries over the years 2004–2014 including data on point-of-sale terminals, financial cards in circulation, and the value of total card payments. Using the first principal component of these variables as a proxy for cashless payment technology, we find that a 1% increase in underground activity lowers the impact of cashless technology on the velocity of currency in circulation by 0.3%. This decrease is large enough that the average marginal effect of cashless technology on currency velocity is statistically insignificant for several high-shadow countries over the sample period. Overall, our results suggest that government subsidization of digital payment infrastructure will be ineffective when shadow markets are prevalent.

Date: 2021
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DOI: 10.1080/00036846.2020.1813246

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