Solving deflation with a monetary starting-over

Several times in monetary history, a government has tried to stem hyperinflation by re-denominating its currency.  Pesos become ‘New Pesos’. Naira become ‘New Naira’.  Lev become ‘New Lev’.

This allows the authorities to cross off a few noughts on the notes, making mental arithmetic easier.  And to signal that the monetary regime is starting over;  that the new notes will be printed at a much slower rate than the old ones.  It hasn’t always worked.

But it has, sometimes.  Whether the re-denomination had much to do with the successes is harder to say.

But in principle, if it worked, a similar logic ought to be available, in principle, for a country stuck at the zero bound battling deflation.

The government/central bank simply announces that the currency will be withdrawn and re-denominated, and that the new one will be printed at a rate that ensures inflation is on target.  For good measure, to reinforce the psychological impact, the authorities could add a couple of noughts, as a strange inversion of the old nought-removal associated with stemming hyperinflations.  To ram home the point, and to reduce the chance of falling back into the same trap, the new target might be raised above the old one, perhaps, as I have argued before, to 4 per cent [a trick which, unlike the redenomination, could not be undertaken more than once].

It would take time to issue the new notes and coins.  But while these are coming on stream, the old ones would be declared worth x times the new notes to come.  Where, as explained above, x could be 100.  New notes and coin are issued all the time, so this need not be so costly.  In fact the new notes and coins could be designed, cunningly, to resemble the old ones in dimension, so that all the cash handling machinery is not made obsolete.  So long as they have the words ‘New’ written clearly somewhere.

As well as having a cousin in the old anti-hyper inflation policies, this idea is related to proposals to eradicate the zero bound.  Those include separating out the unit of account from the medium of exchange.  That proposal involves declaring a new unit of account, and a trajectory for the exchange rate of it against the medium of exchange, so that there is, in effect, a tax on holding the medium of exchange [allowing negative interest rates to prevail].  In transition to the new notes and coins, the proposal mooted here would involve the co-existence a new unit of account [New Pesos] and the old medium of exchange [old Pesos], although at a fixed exchange rate.

It might work ‘too well’, frightening the populace into thinking that if a couple of noughts can appear overnight, perhaps a few more will creep in over time.  But in that case, the policy will not have come to naught.  Conventional interest rate policy could be used to tighten.

This would be something of an experiment, and could not be undertaken lightly, given the fragile nature of the trust that underpins a monetary system.  But it may be no more radical or hair-brained, and perhaps less so, than abolishing cash, helicopter money or even quantitative easing.


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6 Responses to Solving deflation with a monetary starting-over

  1. I’ve got a better idea: ask Robert Mugabe how to raise inflation. He’s the expert, and I’m sure he could explain how to do it in two minutes. If he isn’t available, I can stand in for him…:-)

  2. am says:

    Zimbabwe was hyper inflation not deflation and hyperinflation just results in a collapse of production. One point worth considering is whether by deflation or hyperinflation the destruction in trust in the currency whether old or new, ensues. The country’s money becomes distrusted and so does its banking system. Hoarding of cash outside the system and saving in forex can follow. The country never gets away from its currency problem. It is better to fix the economic fundamentals rather than do something radical. Go to us dollars while things are being fixed is an option.

  3. Max says:

    Possibly a solution in search of a problem. After all, there’s no symmetry between inflation and deflation. Hyperdeflation is not a thing.

    • Tony Yates says:

      Chronic below target inflation is. The hyper-inflation incidents show that redenomination can reset the rate of change of prices in terms of the unit of account. That’s the conceptual point, which applies here. Whether it would work in practice or not, is, just as it was with stopping hyper-inflations, moot.

  4. Good post. To reinforce the psychological impact even more, capitalize a new central bank to take care of the next generation of notes. Sort of like how the Germans stopped the Weimar hyperinflation by creating the Rentenbank to supersede the Reichsbank (among other things).

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