'Cash in Circulation and the Shadow Economy: An Empirical Investigation for Euro Area...'

In response to the last decade's discussion regarding cash and crime, three researchers have published a working paper 'analyzing the net issues of the national euro area central banks in relation to the dynamics of the shadow economy within a panel cointegration framework.'

Franz Seitz, Hans-Eggert Reimers, Friedrich Schneider further the cash debate with their 20-page working paper titled, Cash in Circulation and the Shadow Economy: An Empirical Investigation for Euro Area Countries and Beyond.

Abstract

We analyze the net issues of the national euro area central banks in relation to the dynamics of the shadow economy within a panel cointegration framework. Besides the total net issues, we distinguish between large, medium and small euro banknotes and take due account of other determinants of cash demand. We find a significant and positive relationship between the net issues and the size of the shadow economy only for medium notes. And this result seems to be driven by the smaller euro area countries. The use of large and small denominations is obviously not driven by the shadow economy. For comparison purposes, we also present panel results for eight non-euro area countries (Australia, Canada, Japan, Norway, Sweden, Switzerland, UK, US). For these countries, we are not able to establish an economically meaningful and statistically significant cash demand equation including the shadow economy.

Excerpt from working paper

It is often (implicitly) assumed in this discussion that anonymous transactions are almost exclusively of the illegal kind and that these illegal activities are predominantly undertaken by cash (Buiter, 2009; Sands, 2016). However, empirical evidence to back this hypothesis is lacking. In the debate about withdrawing the €500 banknote from circulation, ECB Executive Board Member Yves Mersch said:

"European Central Bank officials want to see evidence that high-denomination euro banknotes facilitate criminal activity rather than relying on unproven assertions" (Schneeweiss, 2016).

The head of the ECB’s Currency Management Division also stated that there is no statistically proven link between criminal activity and the use of cash, or, in fact, between the size of the shadow economy and cash (FAZ, 2016). With respect to anonymity, Drehmann et al (2002) wrote:

"There are many reasons why people may prefer anonymity – many of which are connected with "bad" behaviour."

But "bad" does not always mean "illegal". It can also include the small human weaknesses we are prone to. Economic agents do not necessarily want these documented in full in the form of proof of payment. Moreover, large-scale crime that involves huge sums of money often prefers cashless means of payment (Mai, 2016). By using complicated and convoluted cross-border chains of transactions, criminals are remarkably adept at concealing the origin of their funds.

Download CESifo working paper here

Related studies

A study on cash and the shadow economy by Dr. Friedrich Schneider (April, 2017)
Professor Dr. Friedrich Schneider - a teacher of economics at Austria's Johannes Kepler University in Linz - presented a study of the potential relationship between cash use and the shadow economy in Grey Matter: Charting the Development of the Shadow Economy.