RDP 2013-01: Currency Demand during the Global Financial Crisis: Evidence from Australia 5. Conclusion

The global financial crisis resulted in the failure or near-failure of a number of large financial institutions in many countries, putting financial markets around the world under considerable stress. Although the solvency of Australian banks was not in jeopardy, there was a substantial policy response in Australia due to the potential economic and financial consequences of the global financial crisis for the domestic economy. The Australian policy response included large interest rate cuts, substantial fiscal stimulus packages and the introduction of a comprehensive deposit guarantee scheme. Coinciding with these measures, Australian currency demand rose at an unprecedented pace, resulting in an additional $3¼ billion in currency holdings of the non-bank sector.

Around 20 per cent of this rise can be attributed to the normal response of currency holdings to the lowering of interest rates and the increase in incomes from the government stimulus. The remaining 80 per cent of the rise may be due to an increase in precautionary holdings in response to uncertainty in the financial sector, which is consistent with the larger increases in demand for high-denomination banknotes. In addition to the rise in currency holdings of the non-bank sector, the banking sector also built up a larger-than-usual buffer of currency holdings to guard against spikes in customer demand. This meant that there was an additional $5 billion of currency on issue in total at the end of 2008.

The rise in currency demand was not large enough to cause any financial system instability. Indeed, bank deposits rose over the period in question. This suggests a degree of robustness in the Australian financial system that was lacking in some other advanced economies. However, the surge did raise some issues for the RBA's banknote distribution operations. The RBA's contingency holdings were tested, suggesting a prudent increase in these holdings as a precaution against any future crises.

It is somewhat surprising that the rise in currency demand occurred around the time that the Federal Government implemented a deposit guarantee. This may reflect the public reacting to the same news as policymakers, but the public may also have had concerns about short-term liquidity even with the deposit guarantee in place.

Data on banknotes on issue are available on a daily basis. Their value as a leading indicator has not been fully established, but they may give a real-time sense of household and bank behaviour in a crisis, especially when buttressed by information from banks about the source of banknote demand and the motivation behind it. The data may also give a sense of whether financial market turmoil is spilling over into the broader economy.