What Is the Impact of Credit Cards on Demand for Money?

In economics, the demand for money is the aggregate amount of cash that a population chooses to hold in wallets and bank accounts as opposed to saving and investing in mutual funds, certificates of deposits, IRA accounts, gold, houses or any other asset. Credit cards have a small contractionary effect on the demand for money.

Aggregate demand is the total amount of money that individuals, households and firms have in a specified area. Usually the specified area is a country, but demand can also be measured for states or provinces as well as groupings of countries, such as the European Union. Economists disagree on the exact definition of "money" for measurement purposes; a conservative definition is cash plus bank account balances, but some economists add in other assets as well, which they argue have almost as much liquidity (ease with which the asset is used as a medium of exchange) as cash.

Empirical studies by economists generally show that prevalence of credit and debit cards reduces the demand for paper money (see Amromin and Chakravorti, 2007). A grouping of smaller studies found that credit cards in particular reduce the demand for money in the short term because consumers buy goods and services on credit and pay for them as soon as possible, reducing the amount of cash an individual carries as well as the amount held in bank accounts (see Masters and Rodriguez-Reyes, 2004).

Despite Americans' high credit card usage rates, the contractionary effect on the demand for money stemming from credit cards has not halted a long-term trend towards an ever-growing money supply. Stable money supply growth is part of a healthy economy, as it ensures smooth transactions. As an economy grows it generates inflation, which in turn increases prices, and consumers require more money to buy goods and services.

One of the main factors that influences the demand for money is not whether people prefer cash, cards or any other asset, but interest rate levels. When interest rates are low, the demand for money goes up because holding cash results in comparatively little value lost to inflation. Furthermore, the possible value lost by holding cash instead of placing the money in an interest-bearing asset or other investment is comparatively little. When interest rates are high, demand for money declines, as people prefer to put their cash into interest-bearing assets such as bonds and certificates of deposit.

High interest rates do not necessarily lead to a decline in credit card use. In Brazil, where interest rates are notoriously high, credit card use continues to rise, according to The Deal Magazine. Furthermore, high interest rates provide a stronger incentive for consumers to pay for credit card purchases in a timely manner, and if this incentive functions as such, high interest rates do not discourage the use of credit cards.