Payment Technology Cuts the Cash People Hold
Instant payment apps let people settle transactions holding less money, so money demand shifts left and the nominal interest rate falls.
Payment Technology Cuts the Cash People Hold
Money MarketInstant payment apps let people settle transactions holding less money, so money demand shifts left and the nominal interest rate falls.
Start at Equilibrium
The money market begins in equilibrium where money demand (MD) crosses the vertical money supply (MS). The vertical axis is the nominal interest rate and the horizontal axis is the quantity of money. Every household holds some money for transactions rather than earning interest on it, and MD sums those choices across the economy.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Payment Technology Cuts the Cash People Hold, step by step
- 1
Start at Equilibrium
The money market begins in equilibrium where money demand (MD) crosses the vertical money supply (MS). The vertical axis is the nominal interest rate and the horizontal axis is the quantity of money. Every household holds some money for transactions rather than earning interest on it, and MD sums those choices across the economy.
- 2
Paying Gets Faster and Cheaper
Instant transfers, tap to pay, and same-day access to savings mean people can leave funds in interest-earning accounts until the moment of purchase. The same volume of buying and selling now requires less money sitting idle. At every nominal interest rate the quantity of money demanded falls, so money demand shifts left. Spending itself has not dropped; only the cash needed to carry it out has.
- 3
A Surplus of Money Appears
The central bank has not changed anything, so MS stays exactly where it is. At the old nominal interest rate people are now holding more money than they want. They move the excess into bonds, bond prices are bid up, and rising bond prices mean falling interest rates.
- 4
The Nominal Interest Rate Settles Lower
The nominal interest rate falls until people are once again willing to hold the entire fixed money supply, where the new MD crosses the unchanged vertical MS. The quantity of money is the same as before, since only the central bank can change it. The cheaper credit that follows encourages investment and interest-sensitive consumption, a monetary loosening the central bank never voted on.
Where it ends up
Better payment technology lowers the money people must hold for a given level of transactions, shifting MD left and lowering the nominal interest rate while the quantity of money stays fixed.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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