The days of the €500 note could be numbered, and not just because it’s the favourite of crime lords everywhere.
As the European Central Bank ponders pushing its deposit rate further below zero, it finds itself aligned with authorities wanting to curb a means of tax evasion and terrorism financing. If, as mooted by ECB President Mario Draghi, policymakers abolished the region’s most-valuable bank note, they’d also help remove a major barrier to pushing interest rates lower.
Deeper negative rates could at some point push lenders to move their money out of their central bank deposit account and into cash rather than endlessly suffer losses. In the euro area, where the €500 note means the equivalent of $1bn of currency only takes up 3 cubic meters, scrapping that denomination would make it harder to hold large amounts of currency.
Abolishing the largest notes “would allow some further cut in the level of nominal interest rates because it would make the storage of cash considerably more expensive or difficult,” Charles Goodhart, a former policy maker at the Bank of England and a professor at the London School of Economics, said in an interview. “There’s a reasonable chance that we might get an upper limit on the denomination in line with that which any respectable country ought to provide.”
With the Bank of Japan taking its own first foray into negative interest rates last month, a once-impossible-sounding policy tool is becoming mainstream in a world where conventional rate cuts have been used up but inflation is weak and growth fragile. While policy makers in Frankfurt can add to their existing program of asset purchases if need be, they’re also signalling they’re willing to cut their deposit rate below the current minus 0.3%.
While that’s happening, a new push is underway by European governments to stem the ability of money launderers, tax evaders and terrorists to use cash for their activities, in part prompted by the attacks in Paris in November.
One stream, as promoted by the German government to the dismay of the general public, is an EU-wide upper limit on cash payments. Cash represents 80% of retail payments in Germany, and the government initiative prompted an angry petition by tabloid newspaper Bild this week.
The other concerns the abolition of the €500 note.
“That’s a decision for the ECB Governing Council,” Bundesbank President Jens Weidmann said at a press conference in Paris on Tuesday. “Both follow the same goal, which is to curtail illegal activities.”
Weidmann also said the outlook has clouded and that the ECB will discuss its response at its meeting in March. Analysts are already placing bets on a fresh cut in the deposit rate, including JPMorgan Chase & Co’s Greg Fuzesi, who forecasts two 20 basis-point reductions this year. A paper published on Tuesday by Fuzesi’s colleagues, Malcolm Barr and Bruce Kasman, suggests that with tweaks to reserve management the ECB could ultimately go as low as minus 4.5%.
That would bring the ECB close to the furthest below zero that any major central bank has ever gone, and potentially raise questions about whether such a level could be implemented without lenders coming to the conclusion that it would simply be better to bunker their banknotes.
Switzerland and Denmark have implemented a lower rate, minus 0.75%. While there’s little evidence of cash hoarding there, it’s not clear how such a policy would play out in the euro area. The lower it goes, the more officials may have to think about curbing the use of cash or face their policy being subverted by hoarding.
While some officials, in particular Bank of England chief economist Andy Haldane, have thought out loud about how a reduction in cash use could enable lower policy rates, few officials have dared make public proposals. The backlash against the German idea for an upper limit on cash transactions this week is an indicator of how far away a cashless society in the euro area might be.
An ECB spokesman declined to comment further on its plans regarding high-denomination bills. Nevertheless, Draghi signalled on February 1 that a change is coming.
“There are questions on how best to implement a decision, and how to communicate this,” he said at the European Parliament in Strasbourg. “We want to make changes, but we want to make changes in an orderly fashion.”
So at the same time as it responds to concerns about the high value note fuelling criminality, the ECB could also help give itself the maximum possible policy room, according to Ben May, senior European economist at Oxford Economics in London.
“If you are wanting to hoard money for legitimate or illegitimate reasons, then the 500 note is very attractive,” May said. “At minus 0.75%, there must be an element of doubt that people will turn around and hoard cash. If there were more stringent limits the lower bound could be pushed much lower.”