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Demand Deposits and Transaction Technology Innovation

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Demand Deposits and Transaction Technology Innovation DEMAND DEPOSITS AND TRANSACTION TECHNOLOGY INNOVATION Francesco Columba* Abstract The rapid diffusion of ATM and POS during the last decade may have changed money demand patterns; therefore, standard econometric analysis of money demand that do not account for these developments may suffer from a potentially serious omitted variable problem. This paper analyzes the effect of transaction technology innovation on demand deposits. Using panel data for Italy we have two results. First, transaction technology innovation has a positive effect on demand deposits. Second, accounting for this innovation in the regressions significantly reduces the income elasticity of money demand typically detected in the existing empirical estimates. JEL classification: E41. Keywords: money demand, payment economics, transaction technology, ATM, POS. Contents 1. Introduction.......................................................................................................................... 2 2. The spread of ATMs and POS in Italy ................................................................................ 5 3. Existing literature................................................................................................................. 5 4. Methodology and data .........................................................................................................7 5. Results.................................................................................................................................. 9 6. Robustness checks............................................................................................................. 10 7. Conclusions........................................................................................................................ 12 Tables ..................................................................................................................................... 14 Appendix ................................................................................................................................ 23 References .............................................................................................................................. 24 * Bank of Italy, Economic Research Department, via Nazionale 91, 00184 Rome, Italy; tel. +44-790-6653139, +39-347-3816536, fax +39-6-7809402; e-mail: [email protected]; [email protected]. A special thank to Paolo Angelini and Stefano Neri for their helpful comments and suggestions. I would like also to thank Andrea Brandolini, Fabio Busetti, Riccardo De Bonis, Luca Dedola, Dario Focarelli, Eugenio Gaiotti, Luigi Guiso, Luigi Federico Signorini, seminar participants at the 17th European Economic Association Congress, at the Irving Fisher Committee conference, at Bank of Italy and at University of Rome, Tor Vergata, for useful comments and suggestions and Miria Rocchelli for excellent research assistance. All remaining errors are mine. The opinions expressed do not necessarily reflect those of the Bank of Italy. 1. Introduction Krueger: “Have you thought much about how debit cards and the kind of new financial products that are available, how that alters the situation?” (i.e. the money demand function). Baumol: “No, but you've just given me an idea. It's the next thing I'll think about”1. The last two decades have witnessed a wave of innovations in transaction technology (Automated Teller Machines (ATMs), Points of Sale (POS), credit cards). Between 1991 and 1999 in Italy the number of ATMs and of POS increased at an average annual rate of 18.4 and 98.4 per cent respectively; most of the euro-area countries have shared a similar experience. Financial and transaction technology innovation has been considered relevant for the analysis of the stability properties of monetary aggregates. Indeed, ATMs allow easier cash withdrawals from demand deposits, altering the ratio between the cost of holding cash and that of holding demand deposits. Similarly, POS allow purchases to be debited immediately to bank accounts, in principle allowing card holders to economize on cash. However, partly owing to the fact that these phenomena have gained relevance only in relatively recent years, there have been few attempts to account for it, particularly within the framework of traditional time series analysis. The omission of proxies for this kind of innovation from money demand equations may bias the estimated parameters, especially the income elasticity and hence the velocity of money2, and suggests a potential impact on euro- area monetary aggregates that deserves careful scrutiny. 1 Krueger (2001). 2 It can be derived from a standard money demand function, the definition of money velocity of circulation implied by the quantitative equation and the assumptions of stationarity of opportunity cost and of a regime of price stability, that ∆v = (1− β )∆y. Where v is the medium term trend in money velocity and y is the long-term income elasticity of the money demand equation. 2 To investigate this issue we analyze the effect of the spread of ATMs and POS on demand deposits3, by far the most prominent component of the monetary aggregate M34. We use a panel data set comprising 95 Italian provinces from 1991 to 1999, which allows us to achieve identification mainly through the cross-section variability of the data and to overcome some of the problems linked to aggregation biases of the estimates based on national data. This paper contributes to the literature providing evidence on the positive effect of ATMs on demand deposits with a panel data set. Moreover it finds a positive effect of another form of transaction technology, POS, on demand deposits. Finally it hints to a potential bias of time series analyses that overlook the effects of transaction technology innnovation on money demand function. The structure of this work is the following; section 2 describes the spread of ATMs and POS in Italy. Section 3 reviews the existing literature. Section 4 presents the methodology and the data; section 5 discusses the empirical analysis comparing the results with those of other authors. Section 6 reports the robustness checks performed and section 7 draws the conclusions. An appendix describes the data. 3 Demand deposits are named overnight deposits in the European Central Bank definition of the euro- area monetary aggregates. 4 Demand deposits, in June 2003, accounted for 89 per cent of the Italian component of the euro-area M1 and 53 per cent of the Italian component of euro-area M3. In the euro-area monetary aggregates demand deposits accounted for 86 per cent of M1 and 35 per cent of M3. Italian contributions to M1 and M3 accounted for 23 and 16 per cent of euro-area M1 and M3 respectively. 3 Figure 1 1999 No. of ATMs 0 .78 to 1 .23 (20) 0 .64 to 0 .78 (18) 0 .51 to 0 .64 (22) 0 .29 to 0 .51 (21) 0 .18 to 0 .29 (22) No. of POS 10 .5 to 23 .4 (22) 7.9 to 10 .5 (18) 5.9 to 7 .9 (23) 3.8 to 5 .9 (17) 1.9 to 3 .8 (23) Sources: Bank of Italy, ISTAT. The figure shows the distribution of the number of ATMs and POS per thousand residents in the Italian provinces in 1999. 2. The spread of ATMs and POS in Italy The spread of ATMs and POS was particularly sharp during the 1990s but with differences between the two types of terminal, particularly as regards their distribution within Italy and its pattern of evolution. If we look at the pattern of diffusion of these facilities per thousand inhabitants we can examine the expansion along two dimensions, the time-series and the cross-section. At the national level, over the period the increase in the facilities was substantial for both types of terminal; the number of ATMs per thousand inhabitants increased from 0.2 in 1991 to 0.5 in 1999, while over the same period POS increased from 0.7 to 7.4. As far as the geographical distribution of ATMs and POS is concerned, if we look at Figure 1 showing the situation in Italy in 1999, it is evident at a glance that terminal facilities per thousand inhabitants were widely spread across Italian provinces. In particular, in the northern regions the number increased from 0.3 and 1.1 in 1991, respectively for ATMs and POS, to 0.8 and 10.2 in 1999 (in central Italy from 0.2 and 0.8 to 0.5 and 8.2), while in the southern regions it went up respectively from 0.1 and 0.2 in 1991 to 0.3 and 3.6 in 1999, widening through the 1990s the initial gap between North and South in per capita endowment of ATM and POS terminals. From the evidence presented it is clear that in order to study the effect of the introduction of POS and ATMs on Italian demand deposits exploiting the cross-section variability of the data with a panel analysis, as we do, may give valuable information. 3. Existing literature A theoretical model by Paroush and Ruthenberg (1986) suggests that the introduction of ATMs increases the share of total money constituted by demand deposits at the expense of currency holdings, under the assumption that the cost of holding demand deposits is reduced with the introduction of ATMs. In a Baumol-Tobin model perspective, the lower cost should be the result of the decrease in time, and hence in transaction cost, necessary to 5 draw on a demand deposit. Indeed, their empirical findings are in line with the a priori: more ATMs lead to a higher level of demand deposit holdings and a lower level of currency holdings. Regarding the relevance of using disaggregate data, Mulligan and Sala-i-Martin (1992) argue that estimates of money demand using aggregate time series may encounter some difficulties, particularly
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