Applied Macroeconomics: Employment, Growth and Inflation

by Vivek Moorthy

When inflation is very high, a currency reform (an administrative decision to knock off a few zeroes from the currency and thereby, from all prices) will lower the price level.22 Currency reforms are a dramatic change: they tend to get done only with very high inflation rates. However, this need not lead to a strict vertical downward movement on the Phillips Curve, which relates to the inflation rate. By knocking off the zeroes, the currency reform wills slightly lower the menu costs and enhance the value of small currency that had disappeared from circulation. However, despite the lower price level, inflation is likely to continue if wage and prices agreements continue to increase at the ongoing inflation rate. Both conceptually and practically, lowering the inflation rate is different from lowering the price level. The former involves the prolonged period of economic slack and hardship that lowers inflation and expected inflation via the EAPC process. The latter requires a re-engineering of the payment system replacing old currency with new currency ones.