Being the outcome of a research by eminent scholars led by Prof. Ademola Oyejide, a University of Ibadan Professor of Economics and an expert in Monetary Economics and International Trade. The research was commissioned by Obafemi Awolowo Institute of Government and Public Policy, Lagos.

1. Introduction
It has been announced that a new currency note with a face value of five  thousand naira (N5,000) will soon be introduced into Nigeria’s currency system.  This raises several important policy issues which call for serious analysis, reflection  and debate. Without being privy to the discussion which led to the decision, such  debate will, to an extent, be speculative, unless it is backed by an informed analysis focusing on the objectives of the policy decision, its consistency with other existing policies, and its likely unintended effects (or collateral damage). This note seeks to stimulate debate by offering some thoughts on the required analysis.

As a preamble, however, it is useful to restate the critical functions of money in an economy and to understand why fiat money, the bulk of which is made up of currency notes of various denominations or face values, is susceptible to over-supply relative to the needs of the economy. While money has several other functions (such as means of exchange and unit of account), its most critical function is to serve as a store of value. In this capacity, money is the primary yardstick for measuring value. Hence, money serves as the record-keeping device which not only permits an efficient summary of past transactions in the economy  but is also relied upon to do the same in the future.

Whatever instrument is used as money, therefore, must be as free as possible from distortions. When this is achieved, price stability can be relied upon to ensure an efficient allocation of scarce resources in a market-based economy.

It requires deliberate and committed policy to ensure the establishment and maintenance of price stability in an economy which uses fiat money. The government which issues fiat money has rather strong incentives to violate the requirements of price stability. In particular, the government derives revenue from issuing fiat money and, in addition, can finance its fiscal deficits by simply creating more money. Most governments try to protect themselves from this temptation by giving their central banks a degree of autonomy over the money creation function.

2. Objectives of the New Currency Note
The new currency note will have, at five thousand naira, the highest face value among the notes currently in circulation as legal tender in Nigeria. One can identify at least two plausible reasons for introducing this new currency note. One of these could be simply to raise government revenue, and the other could be to reduce the cost of transactions.

It is easy to show that currency issue yields revenue to government, through its agent, the central bank. Households and businesses which need cash normally access such cash at their banks. The banks, in turn, source their cash from the Central Bank. Paper currency forms the bulk of this cash in Nigeria and it is printed under the authority of the Central Bank. The printing cost is minimal and the same for all currency notes, regardless of denomination. When banks require cash for their customers, they buy it from the Central Bank at face value. In the process, the Central Bank (and hence the government) profits by the difference between the printing and distribution cost and the face value of the currency. Thus, the higher the denomination or face value of a currency note, the higher is the profit which accrues to the currency issuer. In effect, the profit derivable from a unit of the new five thousand naira note will be several multiples of that from a unit of five naira note, given that the cost of printing is the same.

It is also obvious that making large transactions with five naira notes can be more costly than doing the same with five thousand naira notes. The higher the face value of a currency note, the easier and cheaper it is to transport large amounts of money. The problem of transporting currency derives from its size and weight. Both of these tend to diminish as the face value increases. Hence, high value currency notes tend to be cheaper to transport for use in large transactions. Thus, the introduction of a currency note with a high face value could have the objective of reducing transactions cost.

3. Unintended Effects
Even when a policy action has particular desirable objectives at which they are targeted, they may also be associated with unintended effects and, thus, have “collateral damage”. The introduction of the new five thousand naira currency note is likely to generate a number of unintended effects.

First, there is strong historical evidence that the introduction of higher and higher face value currency notes in an economy often signifies a regime of  increased and sustained fiscal deficit financing. This is, unfortunately, a failure-prone strategy because the inflation which it inevitably generates tends to erode the real value of the seigniorage revenue derived. Second, the issuance of high  face value currency notes is likely to be perceived as an indication of government’s  failure to effectively control inflation. Once this perception takes hold, increased  inflation expectations can be built up quite rapidly. These have pushed many  countries into a situation of hyper-inflation in the past, which has typically  culminated in the redenomination or even complete abandonment of the entire currency system.

Third, the issuance of the five thousand naira currency note runs counter to the recent policy of the Central Bank of Nigeria to promote a “cash-less” economy by encouraging the increased use of non-cash transaction instruments. This policy which is aimed at reducing the use of cash has been justified by the need to reduce the burden of the cost of printing and distributing currency notes. The introduction of a high face value currency note actually does the opposite. By reducing the unit cost of printing and transportation, it actually should promote the use of cash.

Fourth, the issuance of the five thousand naira currency note also runs counter to the government’s often repeated commitment to fight corruption. It is widely recognized that large scale corruption tends to be facilitated by the ease with which unrecorded and large cash transactions can be made in any country. Similarly, increased illegal/criminal, drug-related and terrorist activities, as well as money laundering are known to be facilitated by such unrecorded and large-scale cash transactions. The ease with which currency notes with high face values can be transported renders them as ideal facilitating instruments for these kinds of  undesirable activities. In the Nigerian context, the five thousand naira currency note is likely to be such an ideal facilitator.

4. Inflation and High-Value Notes
The close relationship between inflation and the issuance of high-value currency notes is, perhaps, best illustrated with the real life experiences of a number of countries.

During 1975 - 1991, Argentina experienced a period of inflation during which increasingly higher face value notes were issued. At the beginning of 1975, the highest denomination was 1,000 pesos. This rose to 5,000 pesos in late 1976, then to 10,000 pesos in 1979, and was 1,000,000 pesos in 1981. As this trend became clearly unsustainable, a series of currency reforms followed. In 1983, the currency was re-named peso argentino, one unit of which was exchanged for 10,000 pesos. In 1985, another name change occurred, and a unit of the new currency (austral) was exchanged for 1,000 pesos argentinos. Finally, in 1992, one new peso was exchanged for 10,000 australes.

Bolivia had a similar experience during 1984 - 1987. Before 1984, this country’s highest currency denomination was 1,000 Bolivian pesos; which rose to 10 million Bolivian pesos by 1985. In the 1987 currency reform, the currency was renamed Boliviano, a unit of which was exchanged for one million Bolivian pesos.

Two further examples from Latin America include Nicaragua and Peru. Nicaragua’s inflation episode was from 1987 to 1990. In early 1986, the highest denomination was 10,000 cordoba and, by 1987 it was 1,000,000 Cordoba. In the 1988 currency reform, one new cordoba’s was exchanged for 10,000 old  cordoba. By 1990, the highest denomination was 100 million new cordoba.

Finally, in the 1991 currency reform, one new cordoba was exchanged for five million old cordoba. Peru experienced its worst inflation experience during 1988 - 1990. In 1986, the highest denomination was 1,000 units, which increased to 5 million intis by 1991. The currency reform of 1991 created the nuero sol, one unit of which was exchange for one million intis.

Two examples from Europe include Poland and the Russian Federation. In Poland, the highest denomination in 1989 was 200,000 zlotych, which rose to 1,000,000 zlotych, in 1991 and 2,000,000 zlotych in 1992. In the 1994 currency reform, one new zlotych was exchanged for 10,000 old zlotych. In the Russian Federation, the inflation experience over the 1992 - 1998 period led to the creation of new ruble in 1998, a unit of which was exchanged for 1,000 old rubles.

Back home, examples from Africa include Angola, Zaire/DRC and Zimbabwe. Angola experienced hyper-inflation from 1991 - 1995. Its original currency, the kwanza was replaced in 1990 by the novo kwanza. Early in 1991, the highest denomination was 50,000 novo kwanza. By 1994, this became 500,000 new kwanzas. In the 1995 currency reform, one unit of the re-adjusted kwanza was exchanged for 1,000 new kwanzas. By 1997, the highest denomination was 5,000,000 readjusted kwanza. In the 1999 currency reform, the original kwanza was re-introduced, with its one unit being exchanged for one million re-adjusted kwanzas. The highest denomination currency note now has a face value of 2,000 kwanza.

Zaire experienced an inflationary period between 1986 and 1996. In 1988, the highest currency note denomination was 5,000 zaires, which rose to 5,000,000 zaires by 1992. The 1993 currency reform created the nouveau zaire, a unit of  which was exchanged for 3,000,000 zaires. In 1996, the highest denomination was  1,000,000 new zaires. In 1997, the country was re-named the Democratic Republic  of Congo (DRC) and the currency was changed to francs, one unit of which was  exchanged for 100,000 new zaires.

The case of Zimbabwe shows how rapidly things can get out of control. On 5  May, 2007, Zimbabwe issued currency notes with face values of Z$100 million and Z$250 million. On 15 May, 2007, a new bank note of Z$500 million was issued, followed by the issue on 20 May, 2007 of currency notes in denominations of Z$5 billion, Z$25 billion and Z$50 billion. Finally, on 21 July 2007, bank notes with a face value of Z$100 billion were issued. Eventually, Zimbabwe abandoned its own currency and legalized the use of only foreign currencies.

5. Conclusion
Nigeria has been experiencing bouts of inflation for a long time. Efforts to extinguish this dangerous trend have not been successful. The granting of “paper” autonomy to the Central Bank of Nigeria which is rendered ineffective in a regime of strong and growing fiscal dominance does not offer a realistic and feasible solution. The introduction of the five thousand naira currency note may be a step in the wrong direction, and down a slippery slope towards hyper-inflation. It is clearly time to abandon failed inflation-control policies and inadequately thought- through experiments. Effective price stability can only be restored and preserved by removing the mandatory obligation of the Central Bank and the rest of the financial system to finance government’s fiscal deficits.