Tuesday, August 07, 2007

The New Ghana Cedi

Guelph is an artsy city with budding festivals, which has developed around its university. Artists and academics hang out together at the many eating places in the downtown core and the places where live music plays, where we dance, or nod or chat. Atsu is a dear friend from Ghana with a great intellect and the best dance moves. There's so much I learn from him. A.B.

Is the value of the new Ghana Cedi higher than the value of the US dollar?
by J. Atsu Amegashie

In July 2007, the cedi was redenominated through the introduction of a new currency, the Ghana cedi. One Ghana cedi is equivalent to 10,000 cedis. Currently, approximately 0.92 Ghana cedi = $1. Based on this, I have heard people argue that one Ghana cedi has a higher value than $1. This article is triggered by such erroneous arguments.Suppose your monthly salary is $4000 and the price of food is $100. Then you can buy a maximum of 4000/100 = 40 units of food. Suppose now that the government or your employer takes two zeros off your salary. Simultaneously, two zeros are also taken off the price of food. Then the new salary and price that you face are $40 and $1. Again, you can buy 40/1 = 40 units of food. So the quantity of food that you can buy has not changed. Economists say that your nominal (monetary) income and prices have changed but your real income, which is the quantity of good and services that you can buy, has not changed. It is still 40 units of food. Since money is not an end but a means to an end,economic performance is judged by real values not nominal values.In general, when all nominal incomes in an economy increase (decrease) by x% and all prices also increase (decrease) by x%, there will be no change in real income. The inability to understand this is referred to by economists as "money illusion". Money illusion is an example of what psychologists refer to as "framing effects".Suppose the price of kenkey is 10,000 old cedis, then one new cedi (i.e., Ghana cedi) is enough to buy a ball of kenkey because the price of kenkey in terms of the new cedi is 1 Ghana cedi. In effect, the government has taken four zeros off the old cedi but it has also taken four zeros off the price of kenkey and all other goods and services in the economy. Someone whose salary is 500,000 cedis will now receive 50 Ghana cedis. By taking four zeros off the old cedi, all incomes (in terms of the old cedi) have been multiplied by 1/10,000 to get the Ghana cedi (new cedi) equivalent. Similarly, all prices (in terms of the old cedi) have also been multiplied by 1/10,000 to get the Ghana cedi equivalent. So just like the argument above, there is no change in real income.Like any currency, the old cedi could be used to buy bread, kenkey, waakye, the US dollar, etc. The price of the US dollar in terms of the old cedi is 9200 cedis. Once we understand that the US dollar could be treated as a commodity like kenkey, the exchange rate of 0.92 Ghana cedi = $1 is simply the consequence of scaling all prices and income by a factor of 1/10,000. The exchange rate of 0.92 Ghana cedi = $1 does not mean thatthe cedi is valued higher than the dollar. This is the monetary or nominal value of the cedi. The real value of the cedi is measured by the quantity of goods and services that the cedi can buy. As argued above, this has not changed. Indeed, ask yourself this: can 1 Ghana cedi buy more in Ghana than $1 in the USA? The answer is no. This is basis of the distinction in economics between nominal exchange rates and real exchange rates.
What the government of Ghana has done can be illustrated by using Fahrenheitand Celsius scales for measuring temperature. We know that 32 degrees Fahrenheit = 0 degree Celsius. If we were to rescale or redefine this to be 50 degrees Fahrenheit = 0 degree Celsius, this will not make the USA warmer or colder than Canada and other countries that use the Celsius scale. We have only changed the nominal value for “measuring” temperature but not its real value.Recall that prior to 1983 when we had a fixed exchange rate regime (remember there were no Forex bureaux then), there were periodic devaluations of the cedi announced by the government. However, devaluation is different from redenomination. In the case of Ghana, devaluation meant a given percentage change in the nominal price of the dollar in terms of the cedi, without a corresponding percentage change in the prices of all other goods, services and incomes in the economy. Since not all incomes and prices were changed by the same percentage, this had real effects on the economy even more so because the cedi was over-valued. In contrast under redenomination, the prices of all goods, services, and incomes are changed (in the same direction) and by the same percentage.The crucial ingredients for sustained economic growth are good political leadership, accountability, and sound macro economic management. As argued above, this redenomination per se will produce no magic wand. The Bank of Ghana somewhat shares this view in its document titled “Redenomination of the Cedi”: https://webmail.uoguelph.ca/services/go.php?url=http%3A%2F%2Fwww.bog.gov.gh%2Fprivatecontent%2FFile%2FPublicAffairs%2FRedenomination%2520of%2520the%2520Cedi%281%29.pdf. However, the good thing is that redenomination solves the problem of carrying money around in plastic bags, at least for a significant period of time.

*The author, J. Atsu Amegashie, teaches economics at the University of Guelph, Canada.


Christ' Soldier said...


I recently sent a friend $10. US Dollars, How much quantity of goods and services can they purchase with the amount that I sent them? Such as food or other necessities?

Anonymous said...

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Anonymous said...

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