Lose change

And no, that’s not a misspelling in the title

Kazakhstan seems short of change.  Anyone who frequents the shops and restaurants knows that cash transactions are often inexact, because the cashiers lack coins and small bills.  They lack them because the government doesn’t provide them.  It prints a plethora of 10,000-tenge bills but not enough 200-tenge bills to satisfy demand. 

This shortage particularly threatens small businesses.  A large retailer completes many sales each day, so the those in which it incurs a slight loss offset those from which it receives a slight gain.  On net, the lack of liquidity (that is, of ease in spending) costs it little.  A small firm, however, has only a few sales each day, so it is likely to face a relatively large gap between the amount billed and the amount received.  The business must usually resolve this in favor of the customer to keep from losing her to a large rival.  Suppose that the sale is for 4,500 tenge and the customer can provide only either 4,000 or 5,000 tenge, with no change from either side of the transaction.  Either the seller will lose 500 tenge, or the buyer will lose 500.  Then the cashier will probably settle for 4,000.  This gnaws away at the firm’s already-slender profits.  In addition, unlike the large firm, the small one lacks the wherewithal for debit or credit cards, which could have avoided the illiquidity.  In short, although the government sings the praises of small businesses, it has created a stiff obstacle to their success.        

The shortage of small denominations may occur because the government doesn’t forecast reliably the demand for loose change.  And why should it?  The government profits more from large-denomination bills than from small ones.  The 10,000-tenge bill costs only a few tenge to print but can purchase, say, 10 compact discs.  By exchanging these bills for goods, services or debt, the government makes out like a bandit.  Its potential profits from minting a 1-tenge coin are less glorious.

Ingratiating inflation

The government may lack skilled forecasters, although useful models exist.  In theory, the demand to hold tenge depends largely on income, the interest rate, and the cost of going to the bank for a withdrawal.  The government has data about all three of these factors.  Specializing this model to, say, 200-tenge bills is not difficult.  Suppose that the individual’s total demand for money is 10,000 tenge per week.  The cost of withdrawing and storing 50 200-tenge bills is greater than the corresponding cost for one 10,000-tenge bill; but the smaller bill is 50 times more liquid than the larger one.  Calibrating the money-demand model for the high transaction cost and high liquidity of the 200-tenge bill could help forecast demand for small bills…if you have a forecaster.

So how does the government handle the excess demand for monetary change?  By condoning inflation.  As prices rise, a bill or coin buys less than before.  If a CD now costs 2,000 tenge rather than 1,000, then the purchasing power of a 2,000-tenge bill falls from two CDs to one.  As the purchasing power of coins and small bills converges on zero, people will stop demanding them.  Already the 1-tenge coin is little more than a nuisance; the government has had to shrink it so much that it is hard to pick up.  Some day it may be phased out.

We’d rather reduce excess demand for small denominations by providing the amount that people want rather than by destroying their value.  The 1-tenge coin is useful because it is liquid…as long as prices haven’t risen clear out of sight.  Permitting inflation to destroy the coin diminishes the value of money as a unit of account. 

Those, at least, are my thoughts for a penny.  –Leon Taylor tayloralmaty@gmail.com

  

Notes

As economists use the term, “money demand” refers to the demand to hold money – say, in your wallet or checking account – and not to the demand to spend it immediately.  Money demand rises with income, since richer people will want to spend more eventually and so must have cash at hand.  It falls as the interest rate rises, since you would exchange your money for assets, like bonds, that pay off at the rate of interest.  Finally, money demand rises as the cost of a bank trip rises, since you would withdraw a lot of money from your saving account now in order to avoid another costly trip later. 

This “transactions” model of money demand assumes that all denominations are perfect substitutes; that two 5,000-tenge bills will always trade immediately for one 10,000-tenge bill.  In reality, small denominations are often more scarce than large ones, especially in a transition economy, so they are imperfect substitutes.  

Any good textbook on intermediate macroeconomics, like Mankiw’s, discusses the transactions model, which was developed by Baumol and Tobin.

Good reading         

William Baumol.  The transactions demand for cash:  An inventory theoretic approach.  Quarterly Journal of Economics.  November 1952.

N. Gregory Mankiw.  Macroeconomics.  Seventh edition.  2010. Worth Press. 

      

 James Tobin.  The interest elasticity of the transactions demand for cash.  Review of Economics and Statistics.  August 1956.