Why isn't there an "ideal value" for a given currency? [closed]

Question

If a currency can be worth too little (e.g. needing \$10,000,000,000 to buy a loaf of bread) and worth too much (e.g. being able to buy a loaf of bread for $0.00001), why isn't there an "ideal value" (a point, range, or a shifting set of priorities based on market conditions) that a currency could be fixed or drawn toward?

Many everyday transactions are still done in cash, requiring mental calculations from the transacting parties. Too large numbers and too small numbers create transaction costs that, at least for the extremes, cannot be ignored. So conceivably, some "middle" point could be considered "ideal" as regards the efficiency of money as medium of transactions.

What forces may prevent such an "ideal value" for a currency from being established?

Answer 1

Because money is really just arbitrary numbers, and those numbers only really have any meaning in relation to the other numbers in the set. For example:

Average salary is \$50,000 and a entry-level car costs \$10,000. If the price drops by \$5,000, it's well known that sales will go up, ceteris paribus. But what we increased all prices and all wages by a factor of 100,000? Would that change people's behavior in an otherwise identical system? E.G. now the average salary is \$5,000,000,000 and the average car costs \$1,000,000,000 and the price drops 500,000,000, then what happens?

Well there is a fancy economic name for the theory that covers this (which I forget at the moment), but the answer is No, nothing would change. It's quite obvious that humans are very insensitive to absolute price and very, very sensitive to relative price. (There have been several economy-wide currency revaluations in other countries that serve as examples of this.) Adding or taking away a couple zeros at the end of the numbers doesn't change the really make a difference (provided you apply the change uniformly to all numbers everywhere).

The two major problems that hyperinflation a la Weimar Republic cause are 1.) governments are slow moving beasts and don't react quickly enough to start printing 1 billion dollar notes, etc. so you end up having to use a wheelbarrow full of cash for purchases (which in today's economy isn't as big of a concern since almost all money is just electrons in a computer somewhere,) and 2.) changing prices and adjusting to changing prices and adjusting your forward looking predictions about prices are all not costless actions. It takes time and energy to do any one of those three things. Because of that fact, it imposes a very real dead weight loss on the economy as a whole when prices increase or decrease very rapidly. The faster things move, the more costly it is to adjust and the more often you have to do so, so the DWL becomes exponentially greater than a more slowly-paced situation.

Answer 2

There is a long, theoretical answer to your question. I'm going to give a much abbreviated version, and some pointers to some excellent theoretical literature on the topic.

The immediate answer is that the level of the currency doesn't matter, but rather the change in the level of the currency -- or, inflation -- matters. Then the next question is, why don't economists like very high inflation? Or rather, why do economists seem to prefer relatively low inflation?

The short answer to this question (as far as a short theoretical answer can go) is that when you set up a "modern" macroeconomic model -- that is, a Dynamic Stochastic General Equilibrium (DSGE) model -- and add elements to the market portion such that prices have a sluggish or 'sticky' component, and add a central bank which tries to set inflation such that the best society-wide outcomes happen, one of the emergent results is that the monetary authority (the central bank) would like to smooth out a number of possible effects which distort how the private household behaves. A distortion here means that the private household will act in a way that is best for the HH at the micro level, but bad for the economy at the macro level (which then filters back down and is also bad for the household at the micro level). One of these distortions is that the household will want to save some money in a non-interest-bearing asset -- i.e. cash. Basically the household will want to shove some cash in a mattress. However this is not good for the economy as a whole. In this basic version of the model, the central bank can eliminate this distortion by setting inflation to zero.

This result emerges from this basic theoretical model, and is called "the Friedman rule."

Good references to this in more detail are Jordi Gali's NBER working paper, here, specifically the intro and section 5 (specifically, page 21), and Gali's longer monograph, here.

Practically, because inflation is measured with some error, central banks target some value of inflation just above zero, with the goal that "true inflation" will then be somewhere closer to zero. There are other reasons as well, but I unfortunately don't have a great reference for these points. Central banks' annual reports is actually a great place to look here, as the text is written to explain such questions in layman terms. The US Federal Reserve board, and Reserve System Banks (for example the San Francisco Fed and Saint Louis Fed) have some great resources that explain these things. The Bank of England and the Riksbank (Bank of Sweden) also have some excellent resources. (Another expert is welcome to correct this and/or add references!)

Answer 3

When economists worry about inflation or deflation, they are not necessarily worried about the normative value of the currency. The number of zeroes on any given bill only become a problem with massive hyperinflation, like with the Zimbabwean dollar or massive deflation, of which I do not think a given real world example exists (If this is wrong, please correct me). This aspect, I will cover in the second paragraph. What economists worry about is the relative value of the currency. When economists worry about inflation, they often worry about price inflation. They worry that the basket of goods that the public can buy shrinks in size. They worry about increasing food prices, gasoline prices (and energy prices in general), rent prices (in housing), et cetera. Similarly enough, they may also worry about deflation with regards to economic factors like asset prices, which institutions like the Federal Reserve might encourage to rise. In particular, the Federal Reserve's website argues that, "Declining yields and rising asset prices ease overall financial conditions and stimulate economic activity through channels similar to those for conventional monetary policy." The worry here is that falling asset prices will cause a drop in aggregate demand which will drive the economy into a recession, or worse a depression.

With regards to normative values for currencies, having a surplus of bills and coins that are either too little or too much in real terms is a problem. If half the currency in America are pennies, then the treasury's resources are producing money that is impractical to use for common, everyday use. Even today, the common disdain for getting change in pennies is shown through social media. One problem I could see with a currency having too many zeroes in its common denominations is if the public falls for the psychological effect known as the money illusion. The money illusion happens when people think in nominal terms as opposed to real terms. People overvaluing their currency may be unwanted if it prevents consumers from trading with other currencies. This could possibly lead to a country exporting less because the public has an artificially high demand for their currency (This is a really huge assumption, don't take this claim too seriously) and distorting the exchange ratios between the hypothetical currency and any other real world currency.

One point to note is that Friedman gave an analogy of a helicopter flying over a city and dropping newly printed money evenly across the country to avoid money injection problems (The Optimum Quantity of Money, 1969). I believe (I am no Chicago school economist) that he implicitly claimed that having the normative value of money raise is fine as long as the inflation happens for all those that hold the currency. He argued that the problem was with the method of money injection. Uneven money injection (There is a term for this, and I am hoping that someone will remind me what it is) create distortions in the real wealth of individuals.

As a conclusion, I am not sure if there are any standards for currencies with regards to the number placed on the common denominations of the money. The only example I can think of that would indicate some bounds would be the money illusion, and even that is just speculation on my part.

Answer 4

Brand new currencies do typically aim to start off at the middle ground you describe. The problem is that over time, you have inflation (or more rarely deflation), so that over time the currency veers away from this middle ground.

For example, when the Rhodesian dollar first started in 1970, it was set so that it was roughly the same as a USD, which is perhaps sensible and probably close to what you might consider 'middle ground'. But by 2009, its successor the Zimbabwean dollar had suffered so much inflation that a loaf of bread did indeed end up costing 10^n Zimbabwean dollars (where n was some shockingly large number). When so much inflation happens, the question is whether the government decides whether to lop off a few zeros (by inventing a 'new' Zimbabwean dollar say), abolish the currency altogether (which is what Zimbabwe eventually did), or do nothing whatsoever.

In many countries, the last option (do nothing) is the preferred one. So we have that in Indonesia and Viet Nam, 10,000 of the local currency is a standard measure. And in Japan, 100 yen is a standard measure. But it didn't start off that way. It used to be that 1 yen in Japan could actually buy something substantial. Then inflation took its course.

There have indeed been proposals in some of these countries to lop off some of the zeroes, but the benefit of this must be weighed against the obvious costs of having to reprint all the currency, get everyone to redo their pricing, etc.

Answer 5

First of all, money has three basic functions: a store of value, a medium of exchange, and a unit of account. Markets are able to work with any form of "money" as long as it is able to satisfy each of these conditions. This explains why economies are still able to work with dollars, euros, mackerel, and cigarettes.

You are correct in saying that hyperinflation is bad, but the new numbers produced from the inflation is not necessarily bad. Hyperinflation is merely a high rate of inflation and causes an overall increase in the prices of goods. The reason inflation/hyperinflation is bad is because it destabilizes the money as a store of value. The money is able to perform best in the economy when it can best fulfill it's three-pronged purpose.

Also, remember that the market prices are completely dependent upon the supply and demand of the good. Let's say that you want to purchase a good but will only buy it if it cost less than a certain amount, say one hour of your per hour wage. Let us also say that the good is being sold at the price of one hour of your per hour wage. In this example, regardless of how much the prices have been changed by inflation, you are still going to value the good at the same "price"; the good still costs you the same amount of time and effort (in this example, one hour at your job).
In the strictest sense, the price of the good does not matter. The value of the good is determined by how much you are willing to pay for it, and you arbitrarily decided that you would not pay more than the per hour value of your job. Because the value that you assigned the good is not an objective number value, it is impossible for us to find a good's "ideal value" and keep the price "anchored" to that standard.