The economics of cash shortage

Abstract

Many economies of the former Soviet Union have experienced cash shortages: people with demand and savings deposits in the banking system are unable to convert them into currency. Usually this is attributed to the common use of the ruble. The author argues otherwise. According to him: (a) cash shortages are manifestations of financial disintermediation: the banking sector is unable to attract enough voluntary deposits; (b) cash shortages allow the government to hold inflationary pressures in check; (c) solutions to the cash shortage problems that rely on printing newcurrency will lead to accelerating inflation. More appropriate solutions (increasing the nominal interest rates, for example) involve reversing the economic incentives to financial disintermediation. Excess demands for cash reflect conditions in financial markets. The phenomenon of cash shortage is related to the concept of shallow formal financial markets. This shallowness is recent in the former Soviet Union. The burst of inflation in early 1992 removed the"ruble overhang"and greatly reduced all indicators of financial depth. Continuing shallowness is a direct consequence of financial disintermediation because of negative real interest rates.Banks&Banking Reform,Economic Theory&Research,Financial Intermediation,Environmental Economics&Policies,Rural Finance