More on the N5000 bill and inflation

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.

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4 thoughts on “More on the N5000 bill and inflation

  1. I disagree with your causality argument simply for the fact that in Nigeria, things do not necessarily work out the way it does in other climes. For e.g. in other places, the higher you go in an apartment, the more expensive it is, not in Nigeria (at least generally). Same for antiques, cars, in other climes, you pay more to have access to such old items, in Nigeria, the newer and shinier your item is, the more you are respected. In other words, I am pointing out that our value system for appreciating or ascribing value to certain things are usually different from other parts of the world. Because Nigerians associate coins with being poor as opposed to it being a unit of currency value, thereby enabling completion of smaller transactions, it means no one will carry coins around therefore leading to more items being adjusted to the nearest full Naira instead of to a decimal place or kobo. Now the N5, N10, N20 & N50 notes are to become coins. As many Nigerians will no longer carry these denominations from our averse nature to coins, it will mean a lot of items will simply be adjusted to the nearest whole hundred! This is how I have known Nigerian transactions to work since I’ve been old enough to spend money.

    Now to the issue of the mistiming or complete irrelevance of introducing a higher denomination in the light of the very sensible “Cashless Policy” running at the same time – I daresay that cost of transactions will fall drastically once the cashless policy kicks in fully. Even if I need to pay for a small transaction, I would rather use a POS once this is running full steam and most people will be forced to carry cards around if they realise that the option available to them are payment with cards.

    Like I mentioned to some friends, if the CBN’s reason for introducing higher denomination is currency or cash management, they might as well introduce N10,000, N20,000, N50,000 & N100,000 notes. Afterall, it is meant to be able to aid movement of cash esp for our “rulers”.

    1. 1. Nigerians are as normal as everyone else. The reason lower floors are cheaper is because there is no electricity, no lifts, and you have to walk up every time. Not because Nigerians have brains wired differently. Do Nigerians not carry coins because they hate coins or because the coins are now worth very little? Think about if you would reject a N1000 coin :).

      2. The cashless policy is not just for cashless sake. It is to reduce the cost of transaction especially for small every day transactions. The only thing cheaper than using fewer notes is using no notes. The new bills on the other hand are targeted at reducing costs for larger transaction. The goals are the same…reduce the physical amount of notes used.

      Finally if inflation remains above 10% you should expect a N10000 note perhaps in 10 years time. Hopefully technology should have progressed enough to make the irrelevant.

      Oh and N50 is still a note, not going to be coined.

  2. I am an economist and I want you to believe, Mr. Author, that ur ideas are devoid of all economic standings. The reason being that you see the introduction of the NGN 5000 notes as an occurrence in unity but failed to consider that the introduction is not a problem in itself but the increase in money supply in the economy…

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