World steps up to study India’s cash ban, PM looks away

Bloomberg

Prime Minister Narendra Modi’s administration hasn’t assessed the impact of one of history’s most sweeping changes in currency policy.
“No Madam,” was the Indian junior finance minister’s reply to a lawmaker’s question in parliament on December 14 on whether the government had studied the aftereffects of the move in November 2016 to invalidate almost all of the country’s currency overnight. One of the chief aims of the exercise was to curb corruption in Asia’s third-largest economy.
The decision to look away from demonetisation may be an attempt to distance authorities from what’s since been termed ‘ a total failure’ and a ‘draconian’ act. However, economists all over the world have dug through the rich trove of data, and here’s what they found about the monetary shock that still lingers over India’s economy, politics, society and markets:
Gabriel Chodorow-Reich, economics professor at Harvard University and his colleague Gita Gopinath, now chief economist of the International Monetary Fund, wrote in a paper along with Goldman Sachs Group Inc.’s Chief India Economist Prachi Mishra and the Reserve Bank of India’s Abhinav Narayanan: It was comparable to a 2 percentage point tightening in the key policy rate and reduced economic activity by at least 3 percentage points in the months immediately after. However, the decline in output was relatively smaller and wasn’t fully seen in national gross domestic data, given that these numbers don’t completely capture India’s vast informal economy. They called for deeper evaluations of the long-term consequences of
demonetisation.
Frederick Betz, Timothy R. Anderson and Aurobindh Kalathil Puthanpura at Portland State University used the exercise to test the validity of monetary theory.
The move supported the Chartalist School, which holds that there are crucial differences between currencies in an economy. The withdrawal of so-called Fiat Money, which is currency issued by a government, reduced the availability of Commodity Money, which is used in trade and commerce.
The gap could not be filled by Managed Money, the term used for organised finance, because a large portion of the population lacked bank accounts and the government was slow in replacing currency bills.
It’s clear policy makers didn’t consider how money interacts in India, they wrote. “Was it bad implementation of good policy or bad implementation of bad policy? It was both.”
Rikhil R. Bhavnani and Mark Copelovitch, associate professors of political science at the University of Wisconsin–Madison, say: The economic impact was felt most acutely in relatively “unbanked” and cash-dependent areas.
Still in elections held soon after, Modi’s Bharatiya Janata Party was penalised the least in relatively unbanked districts. This shows that a substantial share of voters supported demonetisation despite its negative economic effects. If Modi hadn’t framed demonetisation as a fight against corruption, there might have been a loss of support to the BJP.