No. 7 - Inside the black box: tools for understanding cash circulation

In this study, we assess the main drivers of banknote circulation in Italy over the last 20 years by using a number of econometric tools proposed in the literature. We explore the role played by banknote flows from abroad and changes in the institutional framework, and we disentangle domestic demand for transaction purposes from other components, including liquidity hoarding. We find that changes in the legal limits on cash payments and money holdings for precautionary reasons explain the bulk of cash dynamics, while the share of transaction demand has declined over time, thus becoming less and less relevant. Finally, we find that, during the COVID-19 pandemic, the exceptional increase in cash circulation was mostly the result of both an increase in precautionary demand due to the rise in economic uncertainty, and restrictions on mobility, which resulted in a marked decline in lodgments at the central bank.