The case of demonetisation in India

News: Popular narratives play a much bigger role in economic policymaking than economists and policymakers acknowledge.

For instance, the Weimar hyperinflation of 1921-24 is deeply embedded in the German consciousness. Even now, nearly 100 years after the event, German society trusts financial stability and distrusts public debt.

Fiscal conservatism remains the dominant narrative and has inhibited the post-2008 recovery in Europe.

Similarly, the demonetisation of high-value currency in India in 2016 is a classic example of policy based on faulty narratives.

How demonetisation was a failure?

Disruption: The demonetisation in 2016 caused widespread disruption in the economy. For instance, personal hardship, the loss of income and savings, and economic slowdown.

Very little of its declared objectives were achieved such as eliminating black money, corruption, moving towards a “less cash and more digital economy”, or increased tax compliance.

Also, more than 99.3% of the cancelled notes were returned to the banks. If black money had existed as stockpiles of illegal cash, clearly all of it was very efficiently laundered.

No difference in tax base: If the objective was to register a permanent upward shift in the tax base, it failed miserably.

Increased use of Physical cash: The cash-in-circulation has now exceeded pre-demonetisation levels. Also, post-COVID-19, reliance on cash is much higher, and with more higher denomination notes in circulation.

How the popular narrative on black money dictated demonetisation policy?

Black money is not really kept in cash except in small quantities but mostly accumulated through real estate and other assets. However, the way the narrative was framed made it hard for critics to explain their opposition.

The folklore of black money: it is easily recognised and understood by the common people, who witness corruption in daily life and they see it in the cinema, newspaper stories, or in daily conversation over the years.

Psychological satisfaction: The idea of dramatic action and the striking of a powerful blow against illegal wealth is deeply satisfying.

Moral issue: To criticise demonetisation would suggest that critics have a vested interest in defending black money and corruption.

Changing narrative: When it became clear that the cancelled currency was being returned to the banks in larger numbers than expected, the narrative changed focus from black money and fake currency to digital/cashless payments.

Linked sub-themes: A key point in selling the story is to introduce complementary sub-themes to reinforce the main narrative. Such as appeals to nationalism and patriotism.

Source: This post is based on the article “The case of demonetisation in India” published in The Hindu on 11th November 2021.