Economics: Removing Zeros from Currency Causes Inflation?

[Chairman Wood]

A while back I was having a conversation with a friend of mine who has much more knowledge then me in Economics. This was a while ago so I might have things confused. I was telling him about South Korea and how their currency the Won is in a position where 1000 Won is worth slightly more than $1USD. I stated that it might be easier if they just removed a zero(or more) because no one ever uses the last holding. He told me that when countries do this with their currency in causes inflation.

Am I remembering what he said correctly or is this completely wrong?

Also why does this cause inflation?

[hmkpoker]

My guess would be that businesses are more likely to round their prices up to the nearest unit than down. Like if they get rid of the penny and have to round to the nickel, things that cost $1.77 will go up to $1.80.

It probably doesn't matter much to the average consumer. The only place it matters is in a large market, where large numbers of very small shares are being purchased. Fortunately in these situations we treat dollars and cents as indefinately divisible and just round to the nearest unit upon completion of the total sum of transactions. Happens with gas too, notice how gas stations charge you weird prices like $1.97 9/10?

[FortunaMaximus]

Psychologial, I suspect. It's been tried in Mexico, and Russia.

I'm not sure the inflation isn't simply already on an upswing when this measure is done anyway. In the case of those two instances, it was an runaway inflatory effect, IIRC.

[Chairman Wood]

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Psychologial, I suspect. It's been tried in Mexico, and Russia.

I'm not sure the inflation isn't simply already on an upswing when this measure is done anyway. In the case of those two instances, it was an runaway inflatory effect, IIRC.

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Could be right. He did cite those two countries as examples. I remember him saying that this did CAUSE higher inflation though. He of course could be wrong and doesn't understand the whole cause/coorelation difference. But I do think that is unlikely. I don't know I'll try to find out.

[FortunaMaximus]

You could compare the trend lines of those two currencies pre and post changeover with, say, the Argentine peso, which did also suffer a severe runaway inflationary effect fairly recently.

I'd be surprised, however, if there wasn't a slowdown in the pace of inflation after the changes were introduce, instead of the reverse. Human nature is cautious when dealing with new stuff. I think of a Russian going, "Matyervebets, what is this worth again?" and basically taking the time to figure out the difference.

[Jasper109]

They chopped 4 zeros off in Poland about 10 or 15 years ago.

10000 Zlotys became 1 Zloty.

I don't think it caused anything to really happen. It just didn't make much sense for a loaf of bread to cost 3000 Zlotys, and coins went back to being more rational small denominations.

[Chairman Wood]

[ QUOTE ]
My guess would be that businesses are more likely to round their prices up to the nearest unit than down. Like if they get rid of the penny and have to round to the nickel, things that cost $1.77 will go up to $1.80.

It probably doesn't matter much to the average consumer. The only place it matters is in a large market, where large numbers of very small shares are being purchased. Fortunately in these situations we treat dollars and cents as indefinately divisible and just round to the nearest unit upon completion of the total sum of transactions. Happens with gas too, notice how gas stations charge you weird prices like $1.97 9/10?

[/ QUOTE ]

This does make sense and probably contributes to at least some of it but I think that he was talking about something on a greater scale then just this. At least an order of magnitude or more.

[mgsimpleton]

The price level is not affected by nominal variables such as price. Reducing the denominations wouldn't affect the buying power of a day's wages.

Printing a new batch of currency would eat up a portion of the countries GDP, so the price level would rise slightly (inflation)

[FortunaMaximus]

Well, that can be accounted for and discounted from the overall inflation rate, no?

Once that's done, and that might be difficult to establish, as the governments that have done this measure are notoriously close-lipped about their spending... It should be a fairly simple process from that point on.

[mgsimpleton]

When the goverment uses 0.01% of the countries GDP, thats 0.01% of your salary lost, so your buying power goes down.