Page 87 - Special Topic Session (STS) - Volume 4

STS566 Richard Finlay
we judge the costs to be acceptable and in any case less than the costs to
society that would be incurred if the RBA was not able to supply public
demand. For a central bank, the costs associated with holding banknote
inventory primarily consist of (i) the opportunity cost associated with interest
foregone on the purchase price of the banknotes (which will vary with the
interest rate cycle, but is currently low for most countries given the setting of
global interest rates); and (ii) when a banknote series is withdrawn, the full
purchase price of any unused old-series banknotes, which become obsolete.
The note-issuing function of the central bank cannot easily effect the
opportunity cost without reducing its buffer holdings, but the second cost
component can be reduced by running-down old-series banknote stocks as
far as is prudent ahead of a new series being released, and/or allowing the old
and new series to co-circulate so that the life of the old-series is not cut short.

4. Sources of banknote demand
To form a long-term forecast of banknote demand and plan strategically,
it helps to understand what factors have driven banknote demand in the
recent past. There are a number of ways one could approach this, including
estimating models of demand using macroeconomic and financial factors as
explanatory variables similar to those discussed above, and then constructing
various scenarios. In this section we take a different approach and use a
number to techniques to estimate how much of recent demand has been
driven by transactional uses of cash, compared with non-transactional uses.
For further details see Finlay, Staib and Wakefield (2018) and Wakefield and
Finlay (2018).

4.1 Transactional banknote demand
The most visible source of banknote demand is for banknotes that are
used to facilitate day-to-day transactions in Australia, which we call
‘transactional demand’. Transactional demand is also the easiest to estimate
since transactional banknotes continuously flow through the cash distribution
system. As a result, we are able to employ a number of different methods to
estimate the size of this source of demand. We first describe each method and
then present a summary of our combined results at the end of this section.

4.1.1 The counting method
Our first approach is to estimate the stock of cash held in various
physical locations that are part of the transactional stock, including banknotes
in wallets, ATMs and bank branches, cash depots, tills and self-service
checkouts and gaming machines, and banknotes held by tourists. These
figures are aggregated to form an economy-wide estimate. This calculation by
necessity relies on a number of assumptions and will miss any cash held in
locations not directly considered. Despite these limitations, the approach is

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