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ABSTRACT

This paper investigates the conditions under which developing and transition nations engage in currency redenomination. Given that many governments of developing countries experience high levels of inflation and deterioration in their currency’s value against other currencies, why do some elect to redenominate, while others do not? And why do some governments wait many years after a bout of hyperinflation or after their currency is priced at 1000 or 5000 units to the dollar, to redenominate, while others do so relatively quickly? I suggest that the explanations rest in a combination of economic and political factors, including inflation, governments concerns about credibility, and the effect of currencies on national identity. I employ survival analysis to test these expectations, using a set of data for developing and transition nations, covering the 1960-2003 period. I find, not surprisingly, that inflation is an important predictor of redenomination. Redenomination also is related to political variables, including government’s time horizons, the governing party’s ideology, the fractionalization of the government and legislature, and the degree of social heterogeneity. Since 1960, governments of developing and transition economies have redenominated their currencies on approximately seventy occasions. These redenominations generally involve reducing the value of the currency by a factor of ten. For instance, in January 2005, Turkey replaced its currency (the Lira) with the New Turkish Lira (YTL), with a conversion rate of one million old lira to one new lira. And in July, Romania introduced a new heavy version of its currency, the leu, with four fewer zeros. In both cases, governments noted that redenomination would send a signal to citizens, as well as to the international community, that economic policy mistakes were in the past.

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