Transitions in currency denomination structure as supply disruption and demand distortion: efficiency, effectiveness and bullwhip

Abstract

Transition from one currency denomination structure to another is infrequent but not rare. Central Banks may adopt such transition for various reasons like prevention of counterfeiting or combating hyperinflation and may include demonetisation of specific denominations or introduction of new denominations. We study transitions in currency denomination from a supply chain perspective. Currency as a product flows through a three-stage supply chain in which currency denominations are substitutable products. We show that demand for a specific denomination depends on the denomination structure and distribution of transactions in the economy. During a transition from one denomination structure to another, the demand for a specific denomination is affected due to change in step size. In addition, the demand may be distorted due to hoarding resulting from supply shortages. Such transaction related hoarding behaviour may occur for lower denominations, in contrast to wealth accumulation related hoarding of higher denominations known in the literature, and can lead to a Bullwhip Effect. We propose efficiency and effectiveness related measures for the remonetisation process and study the impact of prioritisation of supply of one denomination over another on demand distortion. In doing so, we extend the literature on efficient transactions by introducing an aggregate transaction efficiency measure considering the transaction distribution and show how this measure is sensitive to transaction slabs, denomination structures and transaction distributions. Such analysis may inform Central Banks about relative vulnerabilities of different denominations to a supply disruption which distorts currency demand.