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The dire consequences of India’s demonetisation initiative

SUPPOSE that one day the government of a large and fast-growing economy became convinced that its highest priority was to purge the country of black-economy millionaires hoarding piles of illicit cash. Seeking popular approval, it sent the printing presses into overdrive, hoping to inflate away the value of these secret piles of wealth. It worked: rising prices struck a blow against the undeserving rich, and by egging on others to deposit their money in banks (where it could at least earn interest), the shadow economy shrank. The government could plough the newly created money into tax breaks and public-works schemes.

Critics, rightly, would stand aghast. Inflation would affect everyone who held cash, law-abiding or not. Much of the wealth of those enriched by the black economy would be insulated, because lots of their lucre is held not in cash but in property, gold or jewellery. Such heavy-handed measures could undermine the credibility of important government institutions. Fear that they might be used again in future could weaken confidence in the currency as a store of value—paving the way for some broader institutional failure, like hyperinflation….Continue reading

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