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Opinions of Friday, 12 January 2007

Columnist: Adjimah, Harrison

The Eco or the GH (¢), Bank of Ghana decide!

Demonetisation, replacement of the current cedi notes might not a bad option for the economy at the moment. However by openly supporting plans for the Eco, the com-mon currency and at the same time proposing an alternative policy of redenomination of the cedi, the Bank of Ghana might be giving mixed messages, which can create un-certainty with adverse effect on the economy. Moreover, instead of a mere redenomi-nation, a more comprehensive demonetisation program would be more capable of re-storing economic stability

A strong case can certainly be made for a new monetary unit and it is not just for solv-ing cash handling and accounting problems but more importantly to reinstitute and reintegrate the fragmented monetary functions. The economy is currently in a vicious cycle where economic agents, including the government lack confidence in the cedi as store of value, measure of value and to some extent means of payment and are switch-ing to pricing, budgeting and planning in dollars. More dangerously, price changes are being anchored on a variety of indexes and phenomena that are mostly not influ-enced by domestic monetary policy there by rendering the policy highly ineffective. Internal and external instability in terms of high volatile inflation and irregular depre-ciation of the cedi have been a major constraint to Ghana’s economic development over the last four decades. Given the level of the instability over the years, it is also quite clear that the standard macroeconomic strategies of solely relying on budgetary and monetary controls can only achieve slow and inadequate results.

However, there are varied and mixed policy positions on the best strategy for ensur-ing stability and restoring monetary functions. Currently the Ministry of Finance and Economic planning and the Convergence Council of the West Africa Monetary Zone (WAMZ) appear to be working assiduously towards the inception of the Eco by the end of 2009. On the other hand the Bank of Ghana which always appears to be in support of the common currency has in the meantime proposed redenomination by July, 2007.

Over the years a number of policy ideas including official dollarization (actual use of the dollar) have been considered. One can recollect the catching phrase ‘we would strengthen the cedi even if it means using the dollar’’ of the NPP campaign promises, though this has not been mentioned, since the party came into power. The plan for a common currency has been on the drawing board for some time. The inception date has been postponed a couple of times due to the inability of member countries to meet the convergence criteria. At the last Convergence Council meeting, ministers and governors have resolved to forge ahead with the adoption of the Eco by the end of 2009 with or without all the member countries meeting all of the convergence criteria. A major limitation to the permanently pegged regimes such as dollarisation or a common currency is loss of control over domestic monetary policy often at a high cost of slow growth in terms of output, employment and income.

Apparently, the Bank of Ghana is sceptical about member countries being able to meet the convergence criteria. It is also doubtful if such a currency union and a common monetary policy would be in the best interest of Ghana, particularly if the convergence criteria are sacrificed from the onset. A workable currency union re-quires a free trade area and a custom union, something member countries of the WAMZ have not been able to do for a long time. It is also important that the difficult nature and complexity of using one monetary policy to ensure price stability and regu-late growth, in different countries is not taken for granted. This is particularly more difficult when the countries are politically separate and geographically scattered. A recent experience of euro zone is the policy dilemma of what to do when at times some countries experience strong growth and high inflation and others face near stag-nation and deflation at the same time. Another concern is the difficulties of dealing with members, particularly stronger ones in the union if they flout the rules, for in-stance exceed the limit on fiscal deficits.

Of course, in some cases demonetisation has been used to restore monetary function and ensured stability, with the added advantage of retained control of monetary policy. Some successful examples of this are Germany in 1923 and Israel in 1986. A more recent case is Brazil which demonetized (changed currency from the Cruzeiro to the Real (URV)) and reduced a historically high inflation rate since the 1960s from 50% to 2% within 4 months in 1994.

If the currency union is not possible, then the option of demonetisation is not a bad idea. However unless the Bank takes a clear position against the Eco, the debate on the demonetization would be centred on the logic of spending all the efforts and re-sources on such a major policy if it is going to be dumped after a year and half for the Eco. The demonetization should be viewed as an alternative and not “in the mean-time policy” before the adoption of the Eco. The debate should focus on the effec-tiveness of the policy and ability of the economy to absorb the painful adjustment cost.

The obvious advantage of demonetization over a currency union is the retained con-trol over domestic monetary policy. However there are concerns over effectiveness of a mere redenomination (ruling out of four 0s) to reinstitute monetary functions and ensure stability. Another concern is a straight forward redenomination of ¢10,000 to GH¢1 approximates the new cedi to a dollar. Although this may be intended to make the conversion easier, it could end up accelerating the dollarisation phenomenon, with disastrous uncontrollable inflation when the dollar substantially appreciates. There is a lot of spinning, of the stability of the economy going on, however the apparent sta-bility of the cedi to the dollar is largely due to the depreciation of the dollar against other currencies and this would be not permanent.

A successful demonetisation program entails more than a mere redenomination. The success of Brazil was due to the combination of continuous pursuance of prudent fis-cal and monetary policies, imposition of laws and policy incentives, public interfer-ence in private commercial contracts and avoidance of policy surprises and shocks. The process in Brazil began by a daily publication of a new index, the URV by the Central Bank; a law compelling all new contract and wages to be solely anchored on the URV; and incentives to induce agents to index old contracts and other prices on the URV until the unit of account function was completely reunited before the unit of payment function was legally transferred on the URV. As a result of this process, the adjustment in the URV reflected only a change in relative prices although high infla-tion still continued to occur in the Cruziero, the old monetary unit within the period.

In earnest, the already fragile Ghanaian economy cannot be subjected to two major policy changes both of which would have enormous adjustment costs within such a short time. The issues at stake need be look at more deeply and holistically. The benefits of a demonetisation certainly go beyond resolving excessive cash handling problems which could resurface sooner or later so long as inflation remain so high. The other benefits of such a program if it is well design and implemented would be reinstitution and reintegration of the monetary function of the cedi, financial stability, and long term improvement in the payment system and monetary policy effectiveness.

By Harrison Adjimah,
an Economist in Scotland

Views expressed by the author(s) do not necessarily reflect those of GhanaHomePage.