Examining the change of the national currency and its consequences in Iran's economy

Master's Thesis in the Department of Economics, Economic Sciences Orientation

November 2019 

Abstract:

In countries that experience high inflation rates for a long time and the general level of prices increases dramatically, the purchasing power of money is greatly reduced and there is a situation where the national currency can hardly fulfill its duties as a medium of exchange, a unit of measurement and a store of value. It is in such a situation that in order to avoid the costs caused by the circulation of low-value money in the economy, governments change the national currency. Considering the prevailing inflationary conditions in Iran's economy in the last three decades and the significant decline in the value of the rial, the need to change the currency and introduce a far more valuable rial than the old rial is strongly felt. However, statesmen are hesitant to change the national currency mainly due to the concern that such an action would be inflationary.

In this thesis, the costs that the use of low-value banknotes and coins bring to the society are first mentioned. Then, the policy of changing the currency unit has been examined in two ways:

In the first method, a model has been developed to explain the phenomenon of inflation based on economic theoretical foundations, and then this model has been used to examine and draw conclusions about the inflationary nature of changing the national currency in countries that have implemented such a policy. The results of the estimation of this model for a group of countries for which the statistical data needed to estimate the inflation function are available indicate that the change of the national currency in these countries has not only contributed to inflationary conditions, but in some countries it has also led to a decrease in inflation.

The second method by which the inflationary aspect of the currency change policy has been evaluated specifically for the Iranian economy is the use of the demand model for banknotes and coins. For this purpose, the demand function for banknotes and coins has been developed based on theoretical economic principles and it has been estimated using time series statistics from 1338 to 1386 using the collective method. The results show the fact that the policy of changing the currency in the form of removing a few zeros from the Rial, which is accompanied by the printing of larger banknotes compared to the old ones, leads to an increase in the demand for banknotes and muskox, and this acts as a contractionary monetary policy and reduces the money supply, which is an anti-inflationary policy.

In general, the results of the investigations carried out in this thesis confirm that the policy of changing the national currency is not inherently inflationary and The statesmen should not worry about this. 

Keywords: currency change, inflation, aggregation, reliability, error correction model.   

Chapter One

Research Overview

1-1  Introduction

In countries that have experienced inflation at high rates for consecutive years, due to the increase in the general level of prices for exchanging goods. Economically, a large amount of money is required. This makes calculation and accounting operations as well as project evaluation very difficult and makes the national currency look worthless compared to foreign currencies. The most important result of such conditions will be the occurrence of instability and sensitivity of inflationary expectations and the beginning of mistrust in the economy. Many developing countries that have been facing high inflation have been forced to reconsider their national currency to deal with the negative effects caused by the devaluation of the national currency. Changing the national currency as a reform policy has been implemented in many countries. Considering the inflationary trend of recent decades in Iran and the sharp decline in the value of the national currency, it is necessary to reform the national currency in order to reduce the related costs, however, the government officials have not implemented it yet due to the concern of the inflationary effects of the implementation of this policy. In this chapter, a general statement has been made in the field of changing the currency unit.

1-2 statement of the problem

The continued unbalanced increase in the amount of money and as a result the continuous increase in the general level of prices has caused the purchasing power to decrease.

1-2 Statement of the problem

Continued unbalanced increase in the amount of money and as a result the continuous increase in the general level of prices has caused the purchasing power of each piece of banknote and musket to decrease day by day. As a result, the quantity of variables that are measured by currency has increased in such a way that the operation of registering and maintaining accounts and carrying out exchanges has become difficult. When an economy experiences high inflation rates for a long period of time and the general level of prices increases several times,   a large volume of banknotes and coins is required for normal transactions that are carried out in cash. In some cases, the increase in the general level of prices and, as a result, the decrease in the purchasing power of each currency unit reaches such a level that the current currency can hardly play its role as a medium of exchange and a unit of measurement. To deal with the costs caused by such issues, governments have to   They can revise their currency and introduce new money to solve the existing problems. 

Currency change is technically a process according to which the national currency of a country, which has been greatly depreciated due to significant inflation, is revalued, and it is generally done in the form of removing zero from the national currency. The phenomenon of revising the value of the national currency, which is referred to as monetary reform[1] or monetary revaluation[2] in economics, is not a new phenomenon, but by looking at the economic history of countries, we find that many countries have applied this policy in the face of severe inflation. The national currency is not only a mediator of economic exchanges, but also influences the national identity of people and the political authority of governments. The decrease in the value of the national currency leads to people's distrust of the national currency and the spread of foreign currencies in the country. This issue puts a lot of psychological and economic pressure on governments. For this purpose, if the value of the national currency decreases, governments should prevent the weakening of the national currency by applying appropriate policies and try to maintain its value. When the value and position of the national currency is maintained by the public trust of the people instead of gold and silver, governments have serious duties to maintain the value and position of the money. Considering the continuous trend of inflation in Iran's economy during the past decades and the sharp decrease in the value of the national currency, it seems necessary to implement the currency reform policy in Iran. However, the government officials are still hesitant to implement this plan because of the inflationary effects caused by its implementation. For this purpose, in this study, taking into account the experiences of other countries in implementing the national currency change plan, its effects on inflation have been investigated. At the same time, by using the estimation of the demand function for banknotes and muskox, the effect of changes in the demand for banknotes and muskox, after changing the currency and printing banknotes with a higher nominal value, is evaluated on inflation   takes.

1-3 Importance of research

The real value of the national currency in any economy is an indicator of its economic strength and stability, and it is considered one of the main factors of attracting capital, including domestic and foreign capital, to participate in investment and production, which will ultimately lead to economic prosperity by creating new job opportunities and more production. While the devaluation of the national currency,  Not only will it stop investment and production, but it will also cause capital flight, reduce people's trust and increase liquidity in the society. The value of a country's national currency declines when the inflation rate in that country is high for consecutive years and people are forced to pay a larger amount of banknotes and coins to use goods and services, and this is exactly what has happened in Iran over the past years. The per capita amount of banknotes in Iran's economy is much higher than that of advanced countries (114 sheets versus 14 sheets). The modification of the currency or the removal of several currencies from the country's currency has become one of the country's economic needs to facilitate trade exchanges. This is an issue that has been on the Central Bank's agenda for years. Removing zero from the national currency is an action that is carried out with the aim of increasing the nominal value of money. Therefore, considering the inflation situation in Iran in recent years and the government's determination to implement the economic transformation plan, part of which is changing the currency, and the benefits that have been stated for this policy, how to carry out the process and examine the effects of such an action on inflation seems very necessary.