Academic journal article Journal of Money, Credit & Banking

On the Launching of a New Currency

Academic journal article Journal of Money, Credit & Banking

On the Launching of a New Currency

Article excerpt

It is constantly rejected by vending machines, it wears out after just 14 months and has consistently failed to change with the times. But despite this, the world's most famous one dollar bill--the U.S. greenback--is still going strong. Successive attempts to get the U.S. public to embrace the concept of a Dollars 1 coin have failed. Both the Dwight D. Eisenhower dollar, minted from 1971 to 1978, and another minted sporadically between 1979 and 1999 failed to gain currency. The latest attempt to launch a Dollars 1 coin--dubbed "the Golden Dollar," after its appearance rather than its content--is proving considerably more popular, to the extent of becoming a victim of its own success. The Americans like it so much that they are collecting it rather than spending it, creating a headache for the U.S. Mint.

Financial Times, May 26, 2000

CONSIDERING A BROAD DEFINITION of a "new currency," including new-style coins or notes, it is no exaggeration to say that the launching of a new currency is a usual event in the monetary history of a country. New currencies are launched for diverse reasons such as to avoid counterfeiting, to save production or issuing costs, to replace national currencies in the case of monetary integration, or as a means of asserting sovereignty in the case of newly created nation states. Contemporary examples of such launches are offered by the introduction of new currencies in the former Soviet Republics, the U.S. government attempts to introduce a one dollar coin, and the changeover to the euro planned in countries joining the European Monetary Union.

As argued by Selgin (1994), the introduction of a new fiat currency is something to take very seriously. People in general hesitate to adopt a currency different from the one they currently accept. There are several historical examples to validate this statement: the refusal by Nigerians to accept the British currency at the end of the nineteenth century (Ofonagoro 1979), the failure to launch the Susan B. Anthony dollar in the United States at the end of the 1970s, and the difficult introduction of new currencies in Ukraine (Melliss and Cornelius 1994). (1)

The aim of this paper is to determine an appropriate way of launching a new currency, using a dual-currency search-theoretic model. Hansson (1993) observes from the experiences of the former Soviet Republics that there are basically two distinct ways to introduce a new currency. Either it is issued gradually (Latvia, Lithuania, Ukraine), or the government chooses a rapid changeover (Estonia, Kyrgyzstan, Slovenia, Macedonia). Similarly, in attempting to replace notes by coins, some governments decide to withdraw the competing bills, while others choose to let them circulate alongside the new coins (Caskey and St Laurent 1994). Additionally, the old currency can keep its legal tender status (like the one dollar bill in the United States), or lose it once the new currency is introduced (like the kroon in Estonia).

These observations raise the following questions. When introducing a new currency, should the old one be left in circulation, or should the government withdraw the competing form of currency? Should the conversion of the old unit of money into the new one be voluntary or compulsory? Should legal tender be granted to both currencies, or should it be limited to the new one? Simple deduction would suggest an obvious answer to these questions. The government should redeem the old currency completely and reserve legal tender status to the new currency. Unfortunately, such a strategy is not always technically and politically feasible. Therefore, it is of great interest to determine how various constraints can affect the government's ability to introduce a new currency.

To study the launching of a new fiat currency, we adopt the search-theoretic framework of Kiyotaki and Wright (1991, 1993). Trades are decentralized, and agents meet in pairs and at random. …

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