Research Discussion Paper – RDP 2015-10 The Life of Australian Banknotes Abstract
Understanding the life of banknotes is important to a currency issuer's forward planning. Without accurate predictions of banknote life, there is a risk of incurring the economic costs of overproducing and storing excess banknotes or conversely, in an extreme case, of not being able to meet the public's demand. The life of a banknote, however, is not directly observed and must be estimated – a process complicated by the manner in which banknotes are issued and circulated. Often currency issuers use simple turnover formulas to estimate the mean or median life of banknotes; however, such measures tend to be particularly volatile over time as they cannot take into account shocks to currency demand, or changes to currency issuer policies that affect distribution arrangements or the quality of circulating banknotes.
This paper proposes an alternative way of studying banknote life by estimating survival models, which are commonly used in studying life expectancies in medicine or the duration of events in economics. These models can produce estimates of central tendency that are much less volatile over time and provide information on the probability that banknotes survive over time. The models' predictions of banknote survival are intuitive and the results are consistent with samples of circulating and unfit banknotes.