How COVID-19 changes how we spend
ANALYSIS INTO THE IMPACTS OF A CASHLESS ECONOMY AS A RESULT OF COVID-19 ON THE MARGINAL PROPENSITY TO CONSUME
A cashless economy is defined as an economy where all financial transactions are conducted electronically including aspects such as online banking, mobile wallets, bitcoin currency, contactless card payments, online shopping, and electronic monetary transfer apps such as Venmo. The transition from an economy using physical cash (such as coins and banknotes) to electronic transactions has been progressing with the rise of technological advancements.
Due to the rise of COVID-19, social distancing and a minimising of contact have been put in place in all major consumption outlets. Consumers have turned to online shopping and contactless payments such as using Apple Pay or Google Pay to minimise the risk of catching the disease from a pin reader or through hand-to-hand contact when giving and receiving cash. These protective measures will be in place until at least the end of the pandemic, and once people get used to this system, they could easily stay in place indefinitely. This urges the discussion then of how this transition to a cashless economy will affect people, both on a macro-level, concerning the economic effects on the wider society and involvements of institutions, and a micro-level, concerning an individual's marginal propensity to consume and how that affects the economy.
The marginal propensity to consume is the total proportion of an individual’s income that they choose to spend rather than save. In economy theory, the Marginal Propensity to Consume plus the Marginal Propensity to Save equals one (MPC + MPS = 1). This means that there exists a direct inverse relationship between the concepts. Consumers’ marginal propensity to consume is fairly elastic, meaning it is sensitive to change with any external influences ie. people tend to spend less in a recession due to fear that the economy will get worse, which ironically, makes the economy worse due to lack of spending. Increasing consumers’ marginal propensity to consume can be either beneficial or damaging to an economy, depending upon the current state of the economy. For example, if the economy is currently in a recession, increasing consumers’ marginal propensity to consume is beneficial as it creates an influx of demand into the economy which will help to expand the economy, increasing production and thus economic growth in a positive reinforcing feedback loop. If an economy is not in a state of recession, then increasing consumers’ marginal propensity to consume could be inflationary, which is bad for the economy as it can lead to unemployment and stagflation. Considering that experts predict that the COVID-19 pandemic will result in a global depression, increasing consumers’ marginal propensity to consume would be beneficial for most advanced economies.
I hypothesise that a cashless economy could increase consumers’ marginal propensity to consume through creating a disassociation with the value of money by removing the physicality of it. Current research has shown conflicting information, that cashless transactions can increase an individual’s marginal propensity to consume through increase convenience and dissociation with monetary value, yet also that the use of mobile budgeting apps and instant notifications from apps can increase an individual’s marginal propensity to save, which due to the direct inverse relationship, decreases the marginal propensity to consume.
The convenience of contactless payments has increased consumption through the introduction of online shopping. Online transactions have high transparency in terms of financial abstraction. The more transparent (ie. less tangible) a payment is, the higher the marginal propensity to consume due to financial abstraction. Raghubir & Srivastava (2008) illustrates this in their study on how payment methods impact spending decisions, where they found that transactions using non-transparent methods, such as credit cards or electronic wallets, yield a significantly larger amount spent than using physical cash transactions. Raghubir & Srivastava (2008) suggest that the reason for this difference in spending has a neurological basis, theorising that the financial abstraction associated with cashless transactions creates a separation between the act of purchasing and the salience of parting with the payment. Parting with money has been shown to create a neurological pain associated with the loss of an object with high attachment value.
Professor Drazen Prelec (2001) calls this pain of payment a ‘moral tax’ that limits the marginal propensity to consume. Prelec (2001) conducted a study where students were invited to an auction to bid for sports tickets, half the students were instructed to bid with credit card only, the other half with cash only. Prelec (2001) found that card bids were significantly higher. Prelec (2001) theorised that this illustrated the immediacy associated with transactions ie. students using cash would have to pay immediately so had a higher marginal propensity to save to avoid the neurological pain associated with the loss of money, while students using credit cards would not have to pay immediately (as credit cards were only billed at the end of the month) which removed this neurological pain associated with the loss of money. This dulling of the moral tax encouraged students to bid more using cashless transactions.
This theory is further solidified by Gafeeva et al. (2017) who found that the ability to recall purchase history is higher in cash-based transactions than cashless. This impacts willingness to spend in future situations, as Gafeeva et al. (2017) found that willingness to spend is tied to the recollection of past expenditure ie. the higher the recollection of previous expenditure, the lower the marginal propensity to consume which is coherent with other literature.
Research from the Boston Consulting Group (BCG) found that costs from operating a cash-based economy can equate to 0.5% of national GDP in the United States and that switching to a cashless economy can boost the United States’ GDP by 3% through quicker economic growth. Researchers found similar effects in EU countries, where a regression analysis and comparison of five developed EU countries illustrated positive significance between adopting a cashless society and long-run economic growth.
Note: Graph illustrating the impact on GDP of a transition to a cashless economy (Khan et al., 2019).
In a cashless economy, transactions can be easily tracked and traced, making it easier for authorities to investigate and reduce crime rates. Without physical cash, the black market and illegal activity would be reduced as electronic transactions eliminate the anonymity associated with physical cash transactions, making it easier for governments to identify illegal actions, such as concealing income and tax evasion, as well as constricting black market operations, crime, bribery, and corruption or counterfeiting. As transactions now leave a trail this reduces the ability to hide the illegal activity, such as corruption and bribery, which could help institutions become fairer. With technological progress in security, such as encryption and facial recognition scanning, being anonymous in a cashless society becomes nearly impossible making the risk of illegal activity much higher and acting as an effective disincentive for crime, all of which makes for a safer society with less public spending needed to ensure safety. Online crimes such as cyber-attacks, identity theft, and hacking corporations may still occur however without effective encryption mechanisms.
Not only would a cashless economy give public authorities greater ability to implement the law and protect society, but it would also give governmental institutions greater control over monetary policy in the economy. During times of economic recessions and depressions, consumers’ marginal propensity to consume decreases and consumers tend to hoard their money, which ends up further deepening the recession due to lack of spending in the economy. In a cash-based economy, governments have little power over this due to zero lower bounds . Yet in a cashless economy, hoarding decreases as cash is no longer physical and governments can place restrictions on withdrawals so that hoarding is avoided, and implement monetary policy, specifically the implementation of negative interest rates, to increase consumers marginal propensity to consume leading to an expansion of demand in the economy. This is particularly relevant now during the COVID-19 pandemic, which experts suggest will drive the economy into a deep recession. A cashless economy could help the government enable monetary policies that would help the economy to bounce back from the oncoming recession.
A cashless society, however, also has severe limitations such as marginalising the poor and increasing income inequality, as exemplified through the demonetisation in India. People in poverty may not have access to the technology needed in a cashless economy (ie. mobile phones) and homeless people would lose their source of income if cash donations disappeared. Additionally, the elderly may not have the technological intelligence needed to understand and operate online banking and cashless transactions. Governments transitioning to a cashless economy would need to have safety nets and resources put in place to avoid this marginalisation. Furthermore, the introduction of digital currencies (like Bitcoin) could harm central banks’ operations as they no longer have full control of the amount of money in an economy, meaning that monetary policies such as quantitative easing could lose their effect.
A cashless economy could increase the marginal propensity to consume, which can be beneficial for an economy during a recession, yet could hurt income inequality levels. Since the increased spending comes from subconscious influences and cognitive blind spots, it could be considered unethical to transition to a cashless economy without proper protective measures for the poor or the ability to resist overspending.
 The zero lower bound is a macroeconomic issue that describes when policymakers have little to no ability to lower interest rates due to their currently existing rates being extremely low or zero. This is problematic as it could result in a liquidity trap and limits the capacity for central banks to stimulate the economy through the monetary policy of lowering interest rates aiming to increase demand through higher spending leading to economic growth and expansion of the economy. As published on: https://www.theverdictonline.org/post/how-covid-19-changes-how-we-spend