UPDATE (June 13): The Santos administration just announced that it intends to redenominate the currency by the end of 2014.
President Juan Manuel Santos has long wanted to chop three zeros off the Colombian peso, which trades around 1,800 to the dollar. Except for Paraguay, the next weakest in Latin America are the colón and the Chilean peso, which bounce around 500. (Wikipedia has a list of the smallest-value currency units here.) In October 2011, the proposal failed in the Senate by a vote of 41-15. In September 2012, the President reopened the idea, but by February 2013 it was clear that it was not going to happen in this legislative session. The idea remains current, however, and I will not be surprised if it comes back after the peace talks with the FARC are sorted out.
Redenominating the currency is not crazy: France got rid of two zeros in 1960; Israel revalued by a factor of 1,000 in 1986 as did Russia in 1998; Peru hacked off six zeros when the sol replaced the inti in 1991; the next year Argentina cut four zeros off when the peso replaced the austral; Mexico sliced off three in 1993; Turkey hacked off six in 2005; Mozambique redenominated by three orders of magnitude in 2006; Ghana introduced a new cedi at 10,000-to-1 in 2007; and Venezuela chopped off three in 2008 with the introduction of the bolívar fuerte.
The direct cost of introducing a redenominated currency would not be insignificant. In 2010, the Colombian government estimated it around $123 million. (In a sign of the problem with high-denomination currencies, that number turned into $123 thousand on an English-language website!) Printing new bills is cheap: 84% of the cost would come from minting new coins. There would also be an additional $32 million spent in advertising and explaining the change, for a total cost of $155 million.
(Side note: in Ghana, coins were basically out of circulation by the time the government proposed redenominating the cedi. Since coins had to be reintroduced anyway, the monetary cost of redenominating was tiny.)
So why bother? The issue is understudied, but the economics literature (such as it is) focuses on credibility. Few currencies (I am tempted to say none) are denominated in hundreths or thousandths of a euro for long-standing historical reasons. Rather, it comes about either because of a burst of triple-digit inflation (say, Mexico in the 1980s), outright hyperinflation (say, Argentina) or a long period of relatively moderate double-digit inflation (like Colombia; see the below chart.)
So the big economic reason to redenominate, then, is to reiterate that the inflationary period is over, kaputsky, finis. Over here, the Banco Central de Venezuela states four reasons that boil down to making mental math easier and one which says “Leave behind the consequences the history of inflations of the past had on the currency.”
Layna Mosley at UNC-Chapel Hill tried to figure out why countries redenominate. She hypothesized that credibility might be a reason, of course, but she also thought that conservative governments would be also be more likely to redenominate for reasons of national pride. Her evidence was supportive, but not compelling.
Colombia, however, mostly fits her model. (You can read the Colombian authorities’ reasons for wanting to change.) In addition to standard discussions about credibility and easier math, the central bankers mentioned the feel-good pride effect from having a serious currency valued at around half a dollar (or euro or real) instead of some teeny tiny amount. “There is possibly a positive psychological impact since it reduces the gap between local and foreign currency denominations.”
That fits the Mosley model. The final reason, however, does not:
“A countrywide redenomination exercise would also mean all citizens had to exchange their currency, and this could potentially shed light on the country's vast shadow economy. It is thought that drug cartels which operate in Colombia trade mainly with greenbacks. However, officials do not have any definitive figures that prove the extent to which pesos are used in drug trade, and a wide-scale currency exchange could help in this respect.”
And that, ultimately, is why I think Colombia should redenominate.