I wrote a very short post two days ago about my thoughts on the new N5000 bill and the new coins. Got a lot of feedback. The big gripe with it seems to be based around the idea that the new denomination or the introduction of coins will lead to higher inflation.
The gripe is not unfounded. There is an association with higher prices and higher denominated Naira notes. We all know those stores of ..”just a short while ago bread was N10 and now it is N200″. We also know that during the same period we have had a bunch of new notes, N50, N100 and then N500 and then N1000. It is not difficult to see why rising prices are associated with higher denominated bills. But is that really the case? Does the introduction of higher bills lead to higher prices (inflation)? Or in this particular case will the introduction of the new N5000 note lead to higher prices?
Another explanation could be that higher inflation causes central banks to print higher denominated bills. This would also lead to an association between new denominated bills and inflation. It could also be that there is some third factor at play which causes both. In essence this a case of does A cause B or does B cause A. Or does C cause both A and B.
Luckily this isn’t the first time a new denomination has been introduced in Nigeria. Nigeria is also not the first country to introduce new higher denominated bills. This paper by Philip Hans Franses shows that new higher denominated bills do not cause inflation. Causality runs from inflation to new bank notes. The presence of inflation causes central banks, not just in Nigeria, to create larger denominated notes.
The reason for this, like I said in the previous post, is the cost of transactions. It costs more money to do business with a lot of notes than it does with fewer notes. Consider a parallel universe where the CBN loved the currency structure so much that it stuck with N50 as the largest denomination although prices are the same as they are now. Can you imagine the stack of bills you will need to do things as simple as buying a recharge card or kerosene for your stove. For one thing the recharge card seller will need to push a ghana-must-go bag full of notes to the bank everyday.
With the current inflation rate you will need twice as many bills to do the same thing every 7 or 8 years. It makes sense for the central bank to introduce higher denominated bills to deal with the extra costs that arise with that. This ties into the cashless policy too. It is about reducing transaction costs.
I know what you are thinking…this is all macro stuff. How does this affect the common man? Are you trying to tell me that every one walking around with N5000 bills will not increase prices?
I came across an experiment which answers that question. Are you more likely or less like to spend if you have larger denominated notes in your wallet? The answer is less likely. Surprised? You shouldn’t be. The experiment revolves around how people make decisions to “break their money”. People are less likely to make discretionary purchases if they have to break the bills to do so. I am less likely to buy that N20 biscuit if I have only a N1000 note in my pocket. I don’t want to break it just for a biscuit. If I had a N1000 worth of N50 notes…maybe. If I had N1000 worth of N20 notes….what biscuit? I already bought and ate it. Larger denominated bills inhibit spending which if anything should push inflation lower, not higher.
Finally the issue of coins and change. Again the argument goes like this: Nigerians don’t like coins. There will be no change. Because there is no change every one will raise their prices to eliminate the need for change. Higher prices. Inflation. Down with SLS.
Will the introduction of coins push prices up? Consider two
mallams shops on the same street selling the same identical loaf of bread which normally sells for N180. Shop A decides it doesn’t have time to look for change and raises the price of its bread to N200, eliminating the need for change. Shop B goes to the bank every morning to get a stack of change and is able to keep the price of his bread stable at N180. Which shop will you go to for your bread even if you don’t like coins? Probably shop B. You will take your coins home and dump them in can until you are broke. Bottom line is if coins are available people will use them. At least up until the point where N20 becomes as valueless as N1 is today. Then they will disappear. Of course there will be cases where there is just no change, which still happens even with notes. Switching from notes to coins shouldn’t make a significant difference.
There is one inflation worry with this new policy although it is not really about the policy. One of the key drivers of inflation is people expectations about inflation. If, for whatever reason, we all believe inflation will be higher in the future then it will be higher in the future. A self-fulfilling prophecy. Think about what happens if everyone suddenly believes the price of fuel will double the next week. Say an angel came down from heaven and told us and we all believed him/her. We all rush out today, try to fill up our tanks today, creating a spike in the demand for fuel today and causing a scarcity which pushes us all to the black market to buy fuel at higher prices today, even though nothing really happened to increase the price the of fuel. The new bill could have that effect if we all believe it will cause higher inflation. I am confident that won’t happen though. Nigerians are forgetful and we will forget all about the N5000 bill once the next big thing happens.