New Money

• Author: à ke Lönnberg
• Position: was until h recent retirement a Senior Financial Sector Expert in the IMF's Monetary and Capital Markets Department and is now an advisor to central banks and a consulting expert to the IMF.

A popular destination for visitors to the IMF’s Washington, D.C., headquarters has long been a 40-foot-long display of each member country’s currency,

Most countries have their own currency, which is an important part of their national identity, though some belong to a monetary union and share a common currency with the union’s members; others use that of another, often larger, country.

On occasion, a country must introduce a new currency. Turkmenistan, the former Soviet republic in central Asia, decided in 2008 to undertake a currency reform.

A major gap between the official exchange rate and the informal or market rate meant that Turkmenistan’s price system had become complex and inefficient. This, in turn, created complexities in accounting and statistical reporting. So the government decided to introduce a new currency before launching market-oriented reforms. Currency reform was regarded as the foundation for further strengthening the macroeconomic framework, particularly monetary transmission: the more the population relies on the local currency rather than U.S. dollars, the more control the government has over macroeconomic policy.

The total and orderly overhaul of Turk?menistan’s currency system in 2008–09 in many respects serves as a model for other countries.

Big decisions

The introduction of a new currency is not undertaken lightly. The motivation could be hyperinflation, exchange rate collapse, massive counterfeiting of the existing currency, or even war. Or it could be an intentional change—for example joining a monetary union, such as the European Monetary Union.

Changing a national currency is a highly political decision. Sometimes the existing currency does not meet the economy’s needs. The typical economy in need of currency reform is cash based and highly dollarized, with multiple currencies circulating at the same time.

The single most important price in any economy is the price of its currency vis-Ã -vis other currencies. Countries that assign non-market-based exchange rates for different goods or services—or for imports versus exports—tend to have significant distortions in their economy. Over time, this usually leads to slower growth overall. Eventually, the general public, the business community, and politicians may start pressing for currency reform and the introduction of a new currency.

Currency reforms are typically complex and risky: global experience confirms that a successful outcome is never guaranteed. The main ingredient in the successful introduction of a new currency is a strong commitment by the central bank together with the government to take the steps needed to ensure that the new currency is perceived as stable by companies, the general public, and the international community.

Introduction of a new currency comprises four phases. First, the necessary preconditions—sound macroeconomic policies and strong financial sector legislation—should ideally be in place or under way. Next, careful preparation is required, setting up the policies and processes behind the reform and drafting a detailed budget for the entire currency reform (including the cost of printing and minting the new cash currency). Then comes production of the new currency, and finally the most challenging phase: implementation.

Setting the stage

A government facing currency reform often has limited ability to pursue macroeconomic policy. If the country is suffering from hyperinflation, its macroeconomic policies to date by definition were unsound. In some cases, a currency reform must be implemented despite a difficult macroeconomic situation. Currency reform alone is unlikely to resolve such problems and will yield its benefits only if underpinned by fiscal and monetary action. But psychologically, introducing a new currency can itself facilitate the stabilization of an economy. It is sometimes combined with exchange rate unification—to eliminate the complications of both an official...